Understanding Support and ResistanceSupport and resistance are points on a chart where the probabilities favor at least a temporary halt in the prevailing trend.
Support is experienced when demand concentrates around a zone as price is in a downtrend and price finds it difficult to break below that zone. This is because traders have placed a high number of buy orders at the zone, preventing prices from going lower.
Resistance acts like a ceiling on prices when prices are on an uptrend. Prices find it difficult to go above that level because traders have placed a high number of sell orders at that zone making it difficult for an upward thrust beyond that zone.
This USDZAR chart illustrates areas of support and resistance on a chart.
Although they are plotted as lines on a chart, we should not think of them as specific price points but as zones.
A support zone represents a concentration of demand, and a resistance zone represents a concentration of supply. We need to emphasize the word, concentration, because supply and demand are always in balance, but it is the relative enthusiasm of buyers compared to sellers, or vice versa, that is important because that is what determines trends. If buyers are more enthusiastic than sellers, they will bid prices higher until their purchasing demands have been satisfied. Also, if sellers are the more anxious, then they will be willing to liquidate at lower prices, and the general price level will fall.
These are the three principles to follow when analyzing support and resistance zones.
Principle 1: A previous swing high or low is a potential resistance or support zone. Therefore, to identify a potential support, look for previous lows. In the case of a potential resistance, look for previous highs.
Principle 2: Support can reverse its role to resistance on the way up after a violation of the zone. Some elementary psychology will be used to explain this. At the previous support, some buyers went long thinking that price will rise but eventually, price violated or broke the support zone. Now, since no one wants to take a loss, they held on to their positions with the belief that price will rise up again. When price eventually rose to the previous support zone, they closed their positions so as to breakeven, thereby creating sell orders at that zone that made the zone now resistance.
Principle 3: Resistance can reverse its role to support on the way down after it has been violated.
Principles 2 and 3 are what traders call support and resistance flips. Take note of these principles because they are important in the price patterns we are going to trade.
