A story of a battle between the BULLS (Buyers) and the BEARS (Sellers).
This chapter begins our education on how to read Price Action, we will be looking at Support and Resistance and why it works so well and we will also be learning how you can actually plot Support and Resistance for yourself on the chart. Let’s get started!
BULLS vs BEARS
As we have identified already, the BULLS are the buyers and the BEARS are the sellers, but what does that actually mean in terms of price movement on the chart?
As you can see above, the Buyers want to push price up and the Sellers want to push price down. This ties in nicely with what we learnt way back in Chapter 2 – How is Forex Traded?, as we established that opening a BUY trade meant that you were looking for price to go UP and if you opened a SELL trade you were looking for price to go DOWN.
You will often here others in the trading field talk about a particular Currency Pair as being “Bullish” or “Bearish”, a Bullish market means that the Currency Pair is moving upwards i.e. it’s in an Uptrend, a Bearish market means that the Currency Pair is moving downwards i.e. it’s in a Downtrend.
That is trading in a nutshell, it really is as simple as that! Too many people try to complicate trading by making it out to be more complex then it actually is, when in reality it simply comes down to the battle between the Bulls and the Bears. Who has the strength the Bulls or the Bears? and where are they likely to run into opposing forces?
Wouldn’t it be great if we could tell the future and accurately predict which way the market was going to move, we would be Billionaires in a heartbeat. Now even though we know this is not possible, there are still people out there searching for the ‘Holy Grail’ of trading, but the fact remains we can never know with 100% certainty, which way the market is going to move. The closest thing we have to telling the future in trading is Support and Resistance.
What is Support and Resistance?
Support and Resistance is a concept that the movement of price will tend to stop and reverse, at certain predetermined price areas on the chart.
These areas are known as; Support (Buy Area) and Resistance (Sell Area). In other words we can now identify with a fair degree of accuracy, where Buyers and Sellers are located on the chart! Like I said, the closest thing to telling the future.
Unfortunately Support and Resistance is often overlooked by new traders and this is easy to see, when you have so many websites and ‘strategies’ out there that completely disregard it and instead look to sell you an indicator that turns you into a robot i.e. “Buy on this trigger, Sell on that trigger” as we have already covered this is NOT how the markets move, so a method such as this will never work.
Let’s take a look at Support and Resistance on a chart.
There are four major points about Support and Resistance that you should know, let’s take a look at them:
1. Support and Resistance are AREAS
Although I have used lines to highlight Support and Resistance, it is very important to remember that Support and Resistance are not single lines they are AREAS. There is no exact level that Buyers and Sellers are waiting to reach, before they enter Buy and Sell trades respectively.
This can be seen on the chart as price breaks through the line at different levels on many occasions, before going in the opposite direction. It can also turn and proceed in the opposite direction just before hitting the line, so they are areas.
Always remember Support and Resistance are areas on the chart.
2. What happens when an area is broken
The other major point to understand about Support and Resistance, is that when a Support area is broken that same area becomes an area of Resistance. When a Resistance area is broken, that same area becomes an area of Support.
3. The more rejections the better
The more times price is rejected from a particular area be it Support or Resistance, the stronger that area becomes. Think about it, if price went down to an area and was rejected once, there is not much to say it will happen again. However, if price keeps getting rejected from the same area multiple times, it is more likely to hold again as it has done so many times before.
4. The more recent areas tend to work better
The newer Support and Resistance areas that have been established on the chart, will be the ones that work best rather than the older ones. In fact over time these Support and Resistance areas will move by a few pips here and there, for e.g. a solid Resistance no longer rejects price within its current area, it now rejects price a little above the area. This has not just happened once or twice, but multiple times in a row, it is safe to say that this Resistance area has now moved up slightly.
Support and Resistance is the most important factor when it comes to trading, if traders are unaware or have simply decided to ignore Support and Resistance areas on a chart, then everything else they do will not count for much and they are setting themselves up for failure.
For e.g. Let’s say that the current price is just below a Resistance area on the chart. The trader who has no clue about Support and Resistance decides to enter a long trade at the current price, unaware that he is about to buy directly into this Resistance area! A big MISTAKE! He has taken a high risk – low probability trade, the sellers come into the market at the Resistance level and take him out of the trade, the trader is left wondering why he lost.
So we have established that it is very important for you to understand Support and Resistance, but how and why does Support and Resistance actually work? Let’s take a look!
Why does Support and Resistance work?
The reason Support and Resistance works so well, is the fact that most traders will follow the same levels/areas in the market. The Support and Resistance areas you have marked out on your chart, are often the very same areas that have been marked out by other traders all over the World, on their respective charts as well.
So the areas become trading hot-points; for e.g. the Current Price of a pair is starting to go up, towards what has been a very strong and obvious area of Resistance in the past. The expectation is for price to drop back down once it reaches this Resistance Area just like it did before, in other words a lot of selling pressure/bears are due to come into the market and push price down at this very area. Many traders from all over the World start selling at this area as they too recognise it as Resistance and before you know it, the market reverses and comes down.
So you see, when you trade based upon Support and Resistance areas, you are taking a high probability – low risk trade. This is because you have the full force of the market behind you, as they too recognise the same area as either Support or Resistance.
We always want to trade with the majority and against the minority.
You have now learnt what Support and Resistance is as well as why it works so well, the next and final step in this chapter is going to be the icing on the cake, HOW to place Support and Resistance areas on our chart.
How to place Support and Resistance on your chart.
In order to draw Support and Resistance on your chart, the first thing you need to do is to switch to the Daily Chart. Whilst it is true that Support and Resistance can be seen on any time-frame, looking at the Daily Chart allows us to zoom out and see the bigger picture, this is exactly what we want.
The lower time-frame charts are just far too messy to work with, for e.g. on a 1 MINUTE CHART you will see a total of 60 different candles to represent 1 hours worth of data, on the 1 HOUR CHART this same information can be expressed in just 1 candle. So it is far easier to work with a higher time-frame as it is less messy and more compact, remember SIMPLICITY is key in trading.
Also the lower the time-frame you move down to, the less important those Support and Resistance areas are going to be. So what we are aiming to do, is to mark the Support and Resistance areas on the Daily Chart. Let’s take a look at how to do that..
Okay, we are going to be drawing our Support and Resistance on the EUR/CHF Chart.
The first step is to open up the Daily Chart:
What we are looking for are those obvious areas on the chart where price has been rejected, it is quite a simple process. On the image above the Current Price is identified by the dotted orange line. Resistance can be found above Current Price and Support can be found below Current Price.
Plot the Resistance area.
There are two obvious and clear rejections above Current Price, these are marked by the numbers 1 and 2. We can also see if we look to the left at past data, that the same area seems to show indecision as well as some Support. Notice we have called this “Possible Resistance“, that is because we are only looking at some of the data, in order to establish this area as Resistance we must confirm it first.
Confirm the area.
The final step is the confirmation of this area, all we do here is simply look at past data to see how price reacted at this area in the past. Has price used this area as Resistance in the past? Does the area show indecision in the past?
Looking at past data we can confirm this area as Resistance. Let’s look at each number on the above chart to see what it represents.
1. This shows rejection of price at the Resistance area.
2. Price breaks through and then uses the same area as Support.
3 and 4. These show rejection of price at the Resistance area.
5. This shows indecision at the same area of Resistance.
We know from recent data that price will go on to reject the area twice more. So all in all we can confirm that this is a valid Resistance area, however we should take note that as price has broken through on a number of occasions, it seems to be a weak Resistance area. Now let’s look at plotting the Support area, the idea is exactly the same.
Plot the Support area.
There are four obvious and clear rejections below Current Price, these are marked by the numbers 1 to 4. We can also see that after rejection number 1, price broke through the area. It then recovered and broke back up before rejecting the area three more times. As with the Resistance area, the Support also needs to be confirmed.
Confirm the area.
So again the final step is the confirmation of this area, let’s look at past data to see how price reacted at this area in the past. Has price used this area as Support in the past? Does the area show indecision in the past?
The past data shows that this area is indeed a valid area of Support, there are clear rejections at 1 to 4. We can see that price comes down to the Support area and the bulls/buyers come into the market and push price back up. The chart shows quite a strong Support area with multiple/consistent rejections.
So to conclude Support and Resistance areas are simply the areas on the chart, where price has been previously tested and rejected. If we can look back at data and see that price has reacted to a certain area, then there is quite a good chance that it may do the same again.
Just like trading, plotting Support and Resistance is something that you will get better at with time. As you continue to watch the markets you will begin to see these areas with a lot more ease, and they will become more obvious to you. Remember practice really does make perfect, in the meantime if you require any help or if you have any questions feel free to contact me.
This concludes Support and Resistance and the first part of reading Price Action, in the next chapter we will be looking at the second part of reading Price Action which is all about candlesticks. See you there!