When the
market moves up and then pulls back, the highest point reached before it pulls
back is now resistance.
As the
market continues up again, the lowest point reached before it climbs back is
now support.
One thing
to remember is that horizontal support and resistance levels are not exact
numbers.
To help
you filter out these false breakouts, you should think of support and
resistance more of as "zones" rather than concrete numbers.
One way
to help you find these zones is to plot support and resistance on a line chart
rather than a candlestick chart.
Another
thing to remember is that when price passes through a resistance level, that
resistance could potentially become support. The same could also happen with a
support level. If a support level is broken, it could potentially become a
resistance level
Trend Lines
In their
most basic form, an uptrend line is drawn along the bottom of easily
identifiable support areas (valleys). In a downtrend, the trend line is drawn
along the top of easily identifiable resistance areas (peaks).
There are
three types of trends:
1. Uptrend
(higher lows)
2. Downtrend
(lower highs)
3. Sideways
trends (ranging)
Channels
To create
an up (ascending) channel, simply draw a parallel line at the same angle as an
uptrend line and then move that line to position where it touches the most
recent peak.
To create
a down (descending) channel, simple draw a parallel line at the same angle as
the downtrend line and then move that line to a position where it touches the
most recent valley.
1. Ascending
channel (higher highs and higher lows)
2. Descending
channel (lower highers and lower lows)
3. Horizontal
channel (ranging)
Trading support and resistance levels can be divided into two methods: the bounce and the break.
When
trading the bounce we want to tilt the odds in our favor
and find some sort of confirmation that the support or resistance will hold.
Instead of simply buying or selling right off the bat, wait for it to bounce
first before entering. By doing this, you avoid those moments where price moves
so fast that it slices through support and resistance levels like a knife
slicing through warm butter.
As for
trading the break,
there is the aggressive way and there is the conservative way. In the
aggressive way, you simply buy or sell whenever the price passes through a
support or resistance zone with ease. In the conservative way, you wait for
price to make a "pullback" to the broken support or resistance level
and enter after price bounces.
