Support and resistance are one of the most common concepts in trading. As you look at the diagram below you can see a back-and-forth, zigzag pattern which is trending upward — a bull market.
When price action moves up and then pulls back, the highest point it touched before it pulled back is called resistance. When there is a surplus of sellers, resistance becomes apparent. As price action continues, the lowest point it reaches before it starts back up is called support. There is a surplus of buyers at a support level.
So as a chart breathes, support and resistance are continually formed as price action goes up and down over time. The reverse is also true during a downtrend.
The simplest way to explain how support and resistance are normally traded is as follows:
Trading the Bounce
1. Buy when the price falls towards support
2. Sell when the price rises towards resistance
Trading the Break
1. Buy when the price breaks up through resistance
2,. Sell when the price breaks down through support
How to Plot Support and Resistance Levels
The first rule of support and resistance is that these levels are never exact numbers. If a support or resistance level is broken, it doesn’t always mean that it’s going to blow through. Sometimes it means that the market was simply testing that level and it will come back into range. You can see how this plays out on a candlestick chart, where the candlestick shadows are testing the support and resistance lines.
As you can see from the above chart, it may seem like the price was breaking the support level, but in retrospect, we can see that price action was merely testing those levels.
How to Know if Support and Resistance are Truly Broken
This is not an exact science and so there is no exact answer. Take a look at the chart below.
As you can see, the price closed below the support level and then came back above it. If a trader thought that this was a real breakout and sold that pair, they would have been dead wrong — and they’d have lost some money.
In this case, support was not actually broken. It was tested, remained intact, and is now even stronger. Support level was breached but only temporarily.
To help traders discern between real and false breakouts, they should think of support and resistance more as areas or zones rather than specific numbers. For that reason, often support and resistance are interpreted on a line graph. The reason is that line charts show only the closing price while candlesticks visualize the extreme highs and lows, which can be misleading and are often split-second reactions of the market.
Take a look at the line chart below and see support and resistance as zone areas where price forms peaks or valleys in a common area.
A few interesting facts about support and resistance:
When the price action passes through a resistance zone, that zone could potentially become a new support zone — and vice versa.
When price tests a support or resistance zone with frequency and does not break it, that support or resistance zone becomes stronger.
Usually when a support or resistance level breaks, the strength of the follow-through move depends on how strongly the broken support or resistance zone had been holding prior.