Supports and Resistances: A Comprehensive Guide

What Are Supports and Resistances?

Supports and resistances represent price points where the forces of supply and demand meet.

  • Support: A price level where demand is strong enough to prevent a further decline.
  • Resistance: A price level where selling pressure is strong enough to prevent the price from rising further.

Traders utilize these levels as areas to look for potential buy and sell signals.

Identifying Supports and Resistances

The most popular method for establishing these zones is by using previous market turning points.

1. Using Previous Tops and Bottoms

Supports are all possible levels below the current market price, and resistances are all possible levels above the current market price.

  1. Choose a chart of a specific time frame you wish to trade.
  2. Mark the all-time high and all-time low of this time frame using horizontal lines.
  3. Mark all previous tops (reaction highs) and bottoms (reaction lows) between the all-time high and all-time low.

An area with a cluster of marked supports or resistances around the same price level indicates a stronger support or resistance zone.

2. Using Moving Averages

Moving averages also provide important support and resistance zones, especially in a trending market.

  • Add the EMA 20 and the EMA 55 period moving averages to the chart.
  • Mark each average with a horizontal line, similar to how previous tops and bottoms are marked.

3. Identification in a Trading Range

In a trading range (sideways market), there are generally only two significant support and resistance levels:

  • Peaks around the top of the range provide an important resistance zone.
  • Troughs around the bottom of the range provide an important support zone.

The Role Reversal of Supports and Resistances

Supports and resistances can change roles once they are broken:

  • When the price breaks above a resistance level, the broken resistance level can turn into a support level (Previous resistances become potential future supports).
  • When the price breaks below a support level, the broken support level can turn into a resistance level (Previous supports become potential future resistances).

Using Pivot Points

Pivot points offer another technique for finding possible support and resistance levels. They use the prior high, low, and closing price of a higher time frame to determine future levels.

Time Frame Data Usage

  • Intraday Charts: Use the prior day's high, low, and close.
  • Medium-Term Charts: Use the prior week's high, low, and close.
  • Long-Term Charts: Use the prior month's data.

Types of Pivot Points

The most common types of pivot points include:

  • The Standard Pivot (Classic)
  • The Fibonacci Pivot
  • The Denmark Pivot

Calculating Standard Pivot Points

The Standard Pivot Point (PP) acts as the main support or resistance level.

  1. Main Pivot Point (PP): Calculated by averaging the prior high, low, and close price.
    • Formula: PP = (Prior High + Prior Low + Prior Close) / 3
  2. First Resistance (R1): (PP * 2) - Previous Low
  3. First Support (S1): (PP * 2) - Previous High
  4. Additional Resistance (R2): PP + Range of the previous period (Range = Previous High - Previous Low)
  5. Additional Support (S2): PP - Range of the previous period

Trading with Pivot Points

  • If the price finds support on the Pivot Point, it implies further strength towards the next resistance levels.
  • Trading below the Pivot Point suggests weakness towards the First Support (S1).
  • If S1 is broken, it implies further weakness towards the next support level (S2).

Other Pivot Calculation Techniques

  • Fibonacci Pivots: The main pivot is derived similarly to the standard pivot, but the relative supports and resistances are based on Fibonacci ratios (0.382 and 0.618).
  • Denmark Pivots: These use a calculation base that is conditional on the relationship between the closing price and the opening price.

Detailed Summary

This comprehensive guide details the concepts and methods for identifying supports and resistances in financial markets, which are critical price levels where supply and demand forces meet to potentially halt or reverse price movements. Support levels prevent further declines, while resistance levels prevent further rises. Identification methods include using previous market turning points (tops and bottoms), applying Moving Averages (EMA 20 and EMA 55), and analyzing peaks and troughs within a trading range. The text also explains the role reversal phenomenon, where a broken resistance becomes support and vice versa. Finally, it introduces Pivot Points (Standard, Fibonacci, and Denmark) as another technique, explaining their calculation based on prior high, low, and close prices, and how they are used across different time frames to predict future support (S1, S2) and resistance (R1, R2) levels.

Key Takeaways

  • Support is a price level where demand prevents further decline; Resistance is where selling pressure prevents further rise.
  • These levels are used by traders to find potential buy and sell signals.
  • The most popular identification method uses previous tops and bottoms (reaction highs/lows). Clusters indicate stronger zones.
  • Moving Averages, specifically the EMA 20 and EMA 55, also act as dynamic support/resistance, especially in trending markets.
  • In a trading range, peaks form resistance zones and troughs form support zones.
  • Role Reversal occurs when a broken resistance becomes a new support, or a broken support becomes a new resistance.
  • Pivot Points use prior high, low, and closing prices to project future support (S) and resistance (R) levels for various time frames (intraday, medium-term, long-term).
  • The Standard Pivot Point (PP) is calculated as the average of the prior high, low, and close: PP = (High + Low + Close) / 3.
  • Trading above the PP suggests strength toward R1; trading below suggests weakness toward S1.
  • Other pivot types include Fibonacci Pivots (using 0.382 and 0.618 ratios) and Denmark Pivots (conditional on opening/closing relationship).