Introduction To Support & Resistance
The most famous topic in the trading industry is the Support and Resistance. Whatever be the style of trading, Support and Resistance can be considered as one of the most essential aspects of trading. With the introduction of charts, the idea of Support and Resistance exists for a very long time.
Over the years, there are a countless number of strategies available on the internet based on Support and Resistance. People consider it to be a simple topic and usually ignore it. They consider it is a child play. While to the Price Action traders, it is undoubtedly the most vital subject. Now, let us move forward and understand what Support and Resistance mean to a Price Action trader.
What are Support and Resistance?
There are way too many definitions on Support and Resistance out there. It can mean different for different types of technical traders. Some traders consider it to be a pattern and draw lines all over the chart. Note that, there is a logic behind it, and there is a reason why a Support or Resistance level holds and why it does not. Well, let us answer the “why” and discuss what it means to Price Action traders.
Support and Resistance can be defined by just two words, namely, “Wall” and “Memory.” It is called a wall because the market is unable to break through a price. We shall discuss why it is called Memory with an example.
Consider a stock is priced at $100. The price drops to $60. Then again the price slowly makes its way to $100. What happens now? Think about it. The public remembers that last time when the price of the stock was $100, it drastically fell down. Hence, this is stuck in the minds of the public. And when the price comes to $100, they predict that it might fall again. This makes $100 a Resistance level. Similar is the situation for a Support level. So, Support and Resistance is not just a line in the sky but is actually Memory in the minds of the public.
True Support and Resistance
Note that, every retracement and breakout is not true Support and Resistance. Let us understand which levels can be considered as true Support and Resistance and which cannot.
Consider the following example
In the following chart, we see two S&R lines, one green, and the other purple. We wish to determine which one of them is true support and resistance level or which one has a high probability of holding at that level. Well, the answer to it lies in the definition itself. Considering the green S&R line, observe how the red candle goes down.
Question yourself does the movement down cause any panic in public. Nobody remembers the price at which the candle goes down. So, when the price retraces back to the green line, there is very little chance for the level to hold, making it an insignificant level. On the other hand, considering the purple line example, when the price drops from 0.70550 to 0.70100, the public remembers this price where the market went down and are in a belief that the price will drop again when it reaches this level. So, the purple line (S&R line) now has more value.
How Price Action traders read Support and Resistance lines
A real Price Action trader does not read an S&R level as a candlestick pattern but reads more like a business person. An example of the same is given below.
Assume that a person wants to buy 10,000 units of the BMW car. Let’s say the store owners have priced the car at $50K. After the week, they raise the price to $51K. Again after a week time, they raise to $53K. The buyer waits for a discount to buy. The store owners observe the demand for the car, and they raise the price to $60K. The buyer is now in shock. The buyer now remembers the price ($53K) at which the car price rose to $60K. As the prices drop slowly, the buyer waits for the price of the car to come down to $53. Therefore, when the prices come down to levels around $53K, the buyer buys 10,000 cars at that price. Also, the store owners observe this demand coming in and raise the prices again. This $53 level is called Support and Resistance.
Flipping up the above example, assume that you are the owner of a car and you wish to sell it. Consider that you bought the car at $100K. The price of the car now is $90K. You wish to sell it at a higher price, so you wait for a discount. But, instead, the price of the car drops to $60K from $90K. Now, the seller remembers that at $90K, the price dropped drastically. So, the next time the car comes to a price of around $90k, the seller would sell this car. The same is the case with most of the sellers. This causes the prices to drop again. This, in the technical language, is termed as Support and Resistance.
Therefore, all Support and Resistance lines will not work. Only the ones that go hand in hand with the logic mentioned above will work. This is how a Price Action trader brings in a logical story and analyses a Support and Resistance level. To put in a line, Support and resistances are levels that arise out of psychology and memory.