Support and Resistance (Range Trading) Strategy
Support
A support level or zone is a price area
where sellers who have driven prices downwards start to exit their
positions, leaving more buyers to cause the downward slide of prices to
stall. The Price of the asset will therefore find it difficult to go
below that level.
For a support to be valid, it must be
tested several times and be able to withstand downward pressure several
times. Even if a one hour chart or a daily chart shows support being
tested once, a look at the lower time frame charts such as the 1 minute,
5 minute or 15 minute charts will show if the price level has been
tested several times or not. A valid support level is one that has been
tested several times without being breached.
A breach of the support turns that level into a resistance level.
Resistance
A resistance level or zone is a price
area where buyers whose activity has driven prices upwards start to
close their positions, causing a stall in the price advance of the
asset. The price of the asset will therefore find it difficult to
advance above that level.
For a resistance to be valid, it must be
tested severally without being breached, and even if a medium or long
term chart shows resistance being tested once or twice, the shorter time
frame charts will reveal that the price level may have indeed been
tested several times. The more times a resistance level is tested
without being breached, the more valid it is. The chart below shows a
resistance and support level.
Support Becoming Resistance
Trading Support and Resistance
Contract the charts using the zoom tool,
so that you have a wide range of prices to examine. Then using medium
and long term charts such as the 4hour chart and daily chart, you can
identify areas of support and resistance, and then use these areas to
trade as follows:
- The first trade is to enter long at support and exit at resistance as the first profit target. If the move is strong enough to breach the resistance (i.e. bullish candle closes above it), then you can place a Buy Limit order at the resistance-turned support so that the retreating prices that will stall at that level will serve as a trigger for a renewed upward move. The 2nd profit target should then be the next resistance.
- In the same vein, you can go short at resistance and exit at the nearest support as first profit target. If the move is strong enough to breach the support with a bearish candle closing below the support level, place a Sell Limit so that a retracement advance will hit the support now turned resistance, and trigger your trade for the further move to the downside. The second profit target is now the next support.
Please note that the prices may test the
levels several times before eventually breaking them. So always wait
for confirmation of a break of support or resistance before taking the
second trade in each case.
This chart illustrates a short order
using our trade description. The area marked support would be the first
target from the obvious downtrend which the trader would have gone short
earlier on. The support was not broken, so the trader should have
exited the trade at this point. Prices retreated upwards before testing
the support again, this time breaching it (notice the red candle closing
below the support). There were then several attempts by the price to go
back to where they came from, but the support now turned resistance
resisted these moves, and prices moved downwards (took a while though).
Later attempts by the price retracement to breach the new resistance
twice did not work.
This is how to trade using the support and resistance strategy.