Support and resistance is one of the most common methodologies used for trading. It is used for a variety of different asset classes and in this article, I'm going to share how this concept can be applied to accurately pick areas from which to trade in the markets.
First I'll start with some definitions.Support
This is a level that we expect price to reach but not break beyond. Notice I said "break" and not "close". Price can close beyond support and the level remain intact. I will explain in more detail later. Essentially support acts as the floor for price and when price reaches it, we do not expect it to move much lower if it holds. We look to buy at support.Resistance
If support is the floor then resistance is the ceiling. We expect price to reach this level but not break higher. We would look to sell from resistance.Finding The Levels
Much like supply and demand which I've written about before, we are looking to trade away from support and resistance. We only want to trade the best setups so that means learning to identify major support and resistance levels. Minor support and resistance levels will still often produce a reaction but to have the odds in our favour as much as possible, we only want to trade from major levels.
Higher time frames are king so we start with the daily chart. See the AU chart below:
I've marked up both support and resistance here which is evident from the moves that occurred. An even better way to spot these levels more clearly is to use the line chart as below:
With the line chart it's much better to see the market turning points and therefore where we should put our levels.
Now that this has been established, lets' look at short trades from resistance at 0.8083 around January 2018. You'll notice that a green candle closed above, so why do we not consider that broken? For a resistance to be broken, you must have two consecutive coloured candles close in the direction of the break. So here we would need to have seen 2 green candles close above the level, one after the other. We didn't get that. Instead, after the green candle closed there was nothing but red candles. Possible entries were on any of the two red candles that first closed back below the resistance.Managing The Trade
We can clearly see that price entered a downtrend after it hit resistance so it was simply a case of holding and monitoring the trade. If no lower high gets broken, the downtrend is still intact.Lower Timeframes
As you can see, one can simply use the daily chart to find trading opportunities. Many however, prefer to trade on smaller timeframes and that is also fine. I would still analyze the daily chart to determine direction, then drop to say the H1 chart for alternative ways to enter the market.H1
The first opportunity would be to sell at the initial LH after the HL was broken. You would then just hold the trade until a LH is broken. That's a decent move right there. Once the H1 LH is broken, an uptrend is likely on the H1 chart.
As long as the daily downtrend remains intact, the bias is still short. All we would need to do is wait for a H1 HL to be broken and we could enter the newly forming H1 downtrend (as in the example above), knowing that we are still in an overall daily downtrend.
This is how you trend with the trend.
Once a daily LH is broken, then we want to start looking for buys.
Spotting opportunities like these relies on a basic understanding of support and resistance and trend analysis as outlined in this article.
I hope you found this useful.