In our last lesson we looked at the basics of stock, futures, and forex charts. In this lesson we are going to look at something which is known as support and resistance and what these levels tell us about potential future market moves.
As many of you already know, just as anything where market forces are at play, the price of a financial instrument in the stock, futures or forex markets is ultimately determined by supply and demand. Very simply, if demand is increasing in relation to supply then price will rise, and if demand is decreasing in relation to supply then price will fall.
As we have learned in previous lessons, what you are basically looking at when you see an uptrend on a chart is an extended period of time where demand has continued to increase in relation to supply. Similarly when looking at a downtrend you are seeing an extended period of time where demand has decreased in relation to supply for an extended period of time, causing price to fall. Similarly, in a downtrend, demand is continuously falling in relation to supply which causes the price to fall.
In this lesson we are going to look at something known as support and resistance which are price levels where the supply demand equation is expected to change, and price is then expected to stop moving in the direction it was moving previously, or reverse direction.
Support is the price level of a particular instrument in the stock, futures, or forex market where there are enough demand should price reach that level to keep the price from declining further.
The opposite from support is resistance which is the price level of a particular instrument where there is not enough demand should price reach that level for prices to continue to rise.
Chart Showing Support and Resistance in a Range Market
There are many ways to try and determine support and resistance however the most basic way is looking for areas on the chart where the price has touched multiple times (as in the above examples) without breaking through that level. The more times that price has touched a support or resistance without breaking through it the more “valid” that level is thought to be.
A very basic strategy that some traders use is to look for areas of support and resistance and sell as price approaches resistance anticipating a decrease in price and to buy as price approaches support anticipating an increase in price. Support and resistance levels can also be used as take profit targets a concept which we will explore in later lessons.
This is easiest to see in markets which are trading sideways as in the chart above. You can however also spot support and resistance in trends as the trend line and potential trend channel which are drawn to analyze the trend are acting as support and resistance in exactly the same way as they do above.
Chart Showing Support and Resistance in a Trending Market
You should now have a good understanding of the basics of support and resistance. In the next lesson we will look at something called multi-time frame analysis and how you can use this to determine which levels may be good areas to look for potential trading opportunities and which are not.