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Support and Resistance Trading Strategy — A Beginner’s Guide

Sebencapital

Published
06/10/23
Support and Resistance Trading Strategy — A Beginner’s Guide

Certainly, I can rewrite this content for Seben Capital clearly and concisely:

"The strength of Support and Resistance grows with each test they endure. These are the essential lines on your trading chart."

Strategically positioning your stop loss levels at Support and Resistance is crucial for trading forex.

However, adhering unquestioningly to the above "theories" can lead to long-term financial losses. These misconceptions about the Support and Resistance trading strategy are widespread, often perpetuated by trading books and courses.

But there's no need to worry.

After reading this trading guide, you'll be well-equipped to avoid these common pitfalls.

Here's a sneak peek of what you'll discover:

  • Five crucial aspects of Support and Resistance often elude losing traders.
  • How to identify trades with favorable risk-to-reward ratios.
  • Recognizing the signs of impending Support or Resistance breakthroughs, ensuring you don't enter trades at inopportune moments.
  • A robust Support and Resistance trading strategy designed to profit from the mistakes of other traders.

Are you ready to enhance your trading skills?

Let's dive in.

Certainly, I can rewrite this content for Seben Capital:

Fact 1: The more times Support or Resistance (SR) is tested, the less robust it becomes.

Let's start by clarifying the concepts of Support and Resistance:

Support – This is an area on your chart where buying interest is anticipated to be strong.

Resistance – Conversely, this is an area on your chart where selling pressure is expected to be significant.

Now, let's illustrate these concepts with some examples of forex Support and Resistance:

Support-and-Resistance
Support-and-Resistance

Certainly, I can rephrase this content clearly and straightforwardly:

You may have encountered trading books claiming, "The more times Support or Resistance is tested, the stronger it becomes." But in reality...

The more times Support or Resistance is tested, the weaker it tends to get.

Here's why:

Support levels trigger market reversals because they indicate a surge in buying pressure, typically from entities like institutions, banks, or experienced traders executing substantial orders.

Now, picture this scenario:

If the market repeatedly challenges the Support level, it eventually exhausts these buying orders. Once all the orders are filled, no more buyers are left in the market.

In simpler terms...

Multiple-test-of-support

Pro Tip:

When you notice higher lows approaching Resistance, it often leads to a breakout (forming an ascending triangle). Conversely, lower highs nearing Support usually lead to a breakdown (creating a descending triangle).

Let's continue...

Fact 2: Support and Resistance are regions on your chart, not lines.

I admit I also made this mistake by – treating Support and Resistance (SR) as rigid lines on my chart.

Why is this problematic?

Because it can lead to two key issues:

  • Missing out on trades due to price "undershooting"
  • Assuming SR is broken when the price "overshoots."

Allow me to elaborate...

Missing out on trades due to price "undershooting"

This happens when the market gets close to your SR line but doesn't quite touch it. Instead, it reverses in the opposite direction. As a result, you missed the trade because you were waiting for the market to test your SR level precisely.

Here are some forex examples illustrating both over and undershooting of Support and Resistance:

undershooting of Support and Resistance

Price "overshoot" leading to the mistaken belief that SR is breached

This occurs when the market breaks through your SR level, and you conclude it's definitively broken.

As a result, you decide to trade the apparent breakout, only to later discover that it was, in fact, a false breakout.

overshooting of Support and Resistance

So, how do you address these two issues?

It's quite simple – consider Support and Resistance as regions on your chart rather than mere lines.

Why are SR areas on your chart?

This distinction arises because of two types of traders:

  • Traders driven by the fear of missing out (FOMO)
  • Traders aiming to secure the best possible price (Cheapo)

Let me clarify:

Traders with FOMO tendencies tend to enter their trades as soon as the price approaches Support. If there's substantial buying pressure, the market often reverses at that point.

On the other hand, traders seeking the best price often place orders at the lower end of Support. If sufficient traders adopt this strategy, the market reverses near the Support lows.

But here's the catch:

You can't predict which group of traders will dominate – the FOMO or Cheapo traders. Hence, Support and Resistance are viewed as areas on your chart, not just lines.

If you're interested in discovering my secret technique for drawing Support and Resistance, check out this video:

Does this make sense?

Fact 3: Support and Resistance can be adaptable

What you've previously learned about are the traditional, horizontal SR levels (where these areas remain fixed).

However, it's essential to understand that Support and Resistance can evolve, known as Dynamic Support and Resistance.

Now, there are two methods for recognizing Dynamic SR:

  • Employing moving averages
  • Utilizing trendlines

Let me break it down for you...

How to leverage moving averages to identify dynamic SR

I rely on the 20 & 50 Moving Averages (MA) to spot Dynamic Support and Resistance.

Here's an example illustrating Dynamic Support and Resistance in the forex market:

Dynamic Support and Resistance

However, it's important to note that this isn't the only approach. You can opt for the 100 or 200 Moving Averages, which also work effectively.

Ultimately, the key is discovering what suits you best rather than unthinkingly following another trader's method.

Trendlines

Trendlines are diagonal lines on your chart that pinpoint Dynamic Support and Resistance.

Let me illustrate what I mean:

Trendlines are diagonal lines on your chart that pinpoint Dynamic Support and Resistance.

Pro Tip:

Consider Support and Resistance as regions on your chart, whether horizontal or dynamic SR.

Fact 4: Support and Resistance are not ideal locations for your stop-loss

You don't need to be an Einstein to guess where many traders place their stop-loss orders – typically below Support and above Resistance, correct?

Let me provide an example:

Support and Resistance are not ideal locations for your stop-loss

And why is this the least favorable spot to set your stop losses?

Because they tend to get "hunted."

price countinues after stophunt

So, how can you mitigate this issue?

Well, you can't eliminate it, but there are two strategies to help manage it:

Place your stop loss at a distance from SR.

You can utilize the Average True Range (ATR) indicator to achieve this. Here's how:

a. Identify the Support level's low. b. Determine the ATR value. c. Calculate the stop loss by subtracting the ATR value from the low of Support.

If you're eager to delve deeper into this technique

Wait for the candle to complete its close beyond SR

Here's how this strategy operates:

You'll only exit your trade when the price finishes a candle close below the low of Support or above the high of Resistance.

Let me illustrate this concept:

Wait for the candle to complete its close beyond SR

And here's an intriguing fact: did you know that the "real move" often occurs after traders have been stopped from their trades? You can leverage this situation by employing a trading strategy I'll reveal later. But before we get to that, let's explore...

Fact 5: Trading at Support or Resistance provides a favorable risk-to-reward ratio

The common mistake made by many traders is this:

They enter trades when the price is significantly distant from SR. This requires a substantial stock loss and results in an unfavorable risk-to-reward ratio.

Let's look at an example:

Certainly, here's a revised version:

However, if you allow the price to come to you, you can set a tighter stop loss, which enhances your risk-to-reward ratio.

Let me illustrate this concept:

risk-to-reward ratio

Always keep in mind...

In trading, patience pays off. Avoid chasing the markets and allow the price to come to you instead.

Predefine your Support and Resistance areas ahead of time. Then, seek trading opportunities when the price aligns with your designated levels. If the price is elsewhere, exercise discipline and stay out of the trade.

Now...

If you're eager to learn more

How to Anticipate Support or Resistance Breakouts and Avoid Getting "Trapped"

Here's the key takeaway:

  • Support typically breaks in a downtrend.
  • Resistance usually breaks in an uptrend.
  • Support and Resistance tend to break when there's a buildup.

Let's delve into why this happens...

Resistance tends to break in an uptrend,

Here's an essential fact:

To sustain an uptrend, it needs to achieve new highs consistently. As a result, shorting at Resistance becomes a low-probability trade.

Instead, opting for a long position at Support tends to be a more favorable trade.

Support tends to break in a downtrend

Similarly:

For a downtrend to persist, it must continually establish new lows. Consequently, going long at Support isn't a wise move.

Conversely, shorting at Resistance in a downtrend is a sound strategy.

Moving on...

Support and Resistance tend to break when there's a buildup

Consider this scenario:

Support represents an area with the potential for buying pressure, so prices should ascend quickly.

But what if the price doesn't rise and instead consolidates at Support? What does this signify?

Recall the concept from Truth #1:

The more times Support or Resistance (SR) is tested, the weaker it becomes.

Hence, consolidating prices at Support indicates weakness because the bulls couldn't propel the price upward. This might suggest a lack of buying pressure or strong selling pressure. Either way, it doesn't bode well for the Bulls, and Support is likely to break.

Let's illustrate this with an example:

Support and Resistance tend to break when there's a buildup

And the opposite for Resistance:

the opposite for Resistance:

Let's proceed...

A Trading Strategy for Support and Resistance: Capitalizing on Losing Traders

Here's an important observation:

Support and Resistance levels tend to attract significant attention from traders.

Some are looking to trade the reversal, while others seek opportunities in the breakout.

Since trading is a zero-sum game, breakout traders must incur losses for reversal traders to profit, and vice versa.

Do you follow so far?

Great.

Let's explore a Support and Resistance trading strategy designed to profit from breakout traders. Here's what you should do:

1. Identify and mark your Support and resistance (SR) areas.

mark your Support and resistance (SR) areas

2. Wait for a directional move into SR

2. Wait for a directional move into SR

3. Wait for price rejection at SR

3. Wait for price rejection at SR

4. Enter on the next candle with stop loss beyond the swing high/low

4. Enter on the next candle with stop loss beyond the swing high/low

5. Take profits at the swing high/low

5. Take profits at the swing high/low

Support and Resistance trading strategy examples

Losing set-up at (GBP/NZD):

Losing set-up at (GBP/NZD):

Winning set-up at (SOYBNUSD):

Winning set-up at (SOYBNUSD):

Winning set-up at (WTICOUSD):

Winning set-up at (WTICOUSD):

It's crucial to understand that this trading strategy is not a "holy grail." There will be occasions when you lose to breakout traders, just as there will be times when breakout traders lose to you.

The key to long-term survival lies in proper risk management. Hence, I strongly recommend risking no more than 1% of your trading account on each trade.

FAQ:

1. How do we determine the width of Support and Resistance?

An objective method references the Average True Range (ATR). Here's how:
1. Determine the current ATR value.
2. Add 1.5 to 2 times that ATR value to your Support level.
3. This establishes a Support area (similarly for Resistance). You can use this approach to gauge the width of Support and Resistance.
A more discretionary approach is to observe how the price behaves within the Support and Resistance region. For example, whether the price briefly touches Support and is rejected or if it penetrates deeply into Support before being rejected. I use these observations to define the width of the Support and Resistance

2. Is high volume essential for Support and Resistance breakouts?

Based on my research, the volume doesn't play a significant role in determining the authenticity of a breakout. Therefore, high volume is not decisive in confirming whether a breakout is real.

3. Hey Rayner, when you mention "buildup," are you also referring to accumulation?

No, a buildup refers to a tight consolidation phase where candles overlap. Identifying clear Support and Resistance levels or swing highs/lows is challenging during a buildup.
In contrast, accumulation represents a ranging market where the highs and lows are easily identifiable and fluctuate within a defined range.

In Conclusion:

Here's a summary of what you've learned today:

  • Repeated testing weakens Support and Resistance levels.
  • Support and Resistance should be viewed as areas on your chart, not just lines.
  • You can identify Support and Resistance using moving averages.
  • Avoid placing your stop loss just below Support or above Resistance.
  • Trading at Support and Resistance offers a favorable risk-to-reward ratio.
  • We've discussed a Support and Resistance trading strategy.

Now, here's a question for you:

How do you approach a Support and Resistance trading strategy? Share your thoughts in the comments below.

Written by Sauravsingh

Techpreneur and adept trader, Sauravsingh Tomar seamlessly blends the worlds of technology and finance. With rich experience in Forex and Stock markets, he's not only a trading maven but also a pioneer in innovative digital solutions. Beyond charts and code, Sauravsingh is a passionate mentor, guiding many towards financial and technological success. In his downtime, he's often found exploring new places or immersed in a compelling read.

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