Exclusive Article by Adam Halpern, Indicator Warehouse
Support and Resistance
Understanding how support and resistance works is paramount to understanding the markets. Why? Because support and resistance is how the markets work! Support and resistance levels on a chart are just the graphical representation of supply and demand in action, and it is supply and demand that drives the markets.
When demand (buying) is greater than supply (selling) prices will go up. As prices continue higher they reach a point where either the demand for the commodity declines, or the amount of supply increases. Either way, supply ultimately catches up to, and exceeds demand. When this happens prices stop advancing. This is known as resistance. Resistance acts like a ceiling against prices going higher.
Conversely when supply (selling) is greater than demand (buying) prices will decline. As prices fall they reach a point where either the amount of supply decreases or the demand for the commodity increases. As a result demand overtakes supply and prices stop declining. This is known as support. Support acts like a floor keeping prices from going lower.
Identifying Support and Resistance
Since the market tends to move from one resistance level to another, knowing where the important support and resistance levels are can give us an idea of where the market is heading next. But how do you know where the market is going to form support or resistance?
Most traders calculate support and resistance levels incorrectly. Many traders will use an old high or low and assume they've found support or resistance, but it doesn’t work that way. Identifying the most important support and resistance levels requires you to examine the price action to determine at what price the market is most sensitive.
Support or resistance occurs when you have two or more open/highs/low/close, or combination thereof, occurring at, or close to, the same price. When the open/high/low/close intersect at a particular price this forms support or resistance.
Many traders make the mistake of being too tight with their support and resistance figures. Ideally when looking for support and resistance, the combination of highs and lows will be at exactly the same price making it easy to determine the precise support or resistance level. Often times however this is not the case.
Sometimes the highs and lows will not be exact; rather the prices will only be close. The question then becomes: how close do the values have to be in order to still be considered support or resistance?
Prices can form two types of support and resistance:
- Exact Price resistance – when the highs and/or lows meet at an exact price
- Price Zone resistance – when the highs and/or lows are close enough in price to act as support or resistance but are not exact.
To determine if prices are “close enough” you need to look back into the history of the chart to see where the market has reversed off of support or resistance in the past. By examining how close the prices were when the market reacted before, you can get a feel for how close prices need to be to form support or resistance in that particular market in the future.
Counting – Might Makes Right
The strength of a support or resistance level is determined by how many times the market tests that particular price. Each time the price has been hit by either a high or low it counts as one point towards the strength of the resistance level. The more times a support or resistance area has been tested the harder it becomes.
Therefore if you have a price that has been tested 5 times as support and another price that has been tested 3 times as resistance, then the market will likely break through the resistance (3) since it is not as strong as the support (5).
This is a basic premise of trading support and resistance: that all things being equal, the market will always choose the path of least resistance.
An Easier Way
Understanding support and resistance levels is an extremely important skill in any market. Professional Floor Traders are aware of an entire range of major and minor support and resistance levels before the market opens each day. They also know how to calculate new levels as the trading day progresses. However, in spite of its importance, identifying the most important support and resistance levels is a skill that often eludes the retail trader. For this reason many traders will look to a Support and Resistance service to help them identify higher probability support and resistance levels.
It goes without saying that knowing where the market is most likely to turn can give you an incredible advantage during the trading day, an advantage that no trader can afford to be without.
Here's an easer way to see and add Support and Resistance lines to your NinjaTrader charts.
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