How to trade support and resistance?

Trading support and resistance is not hard. If you have been following right from the beginning of this lesson I would expect you to at least be having a hint about it already.

Like any other tool, support and resistance help us to define entry and exit levels on the market charts and predict trade signals. Now that you know how to draw support and resistance levels, let’s take you through on how to trade them.

How you trade support and resistance is the same way you should trade trend lines and channels.

Buy when the price approaches a support and starts bouncing in bullish direction and sell when the price touches a resistance and starts bouncing in bearish direction. Also, buy when the price breaks resistance and sell when the price breaks support. This can be grouped into two ways to trade.

The two ways; Break outs and Bounces.

Let’s start with the breakouts;

Trading a breakout on support and resistance.

Like we said price tends to hold on these levels. If you are to observe the chart below,  you will realize that  at the identified levels of support and resistance price always found it hard to break through.   This would give you a clue as a trader that once price breaks such a level it will rally for some time before making a consolidation a gain.

As most traders tend to believe in these levels, the prophesy tends to come true. But this cannot happen all the time. The fact that the market is driven by people’s feelings and emotions it reminds us that this is not a perfect world so at a certain time price will violet and break through.

AUD/USD, Daily chart shows break outs and bounces on support and resistance levels.

Like we said before, a bounce on support gives a buy signal and on resistance, it gives a sell signal.

On the other hand a break out on support gives a sell signal while a break out on resistance gives a buy signal. Carefully look at the chart above and try to follow price directions after these scenarios.

Let’s us now see how trade support and resistance break outs. 

1.The aggressive way

From our chart above, points circled show price break on the support levels on the market chart. As price moved down, it broke the support line marked 1 giving us a sell signal. For an aggressive trader, entry would be immediately after the close of the breaking candlestick below the support line.  Stop loss would be slightly above your entry level and take profit should be the next support level.

Looking at the above chart, price made a bounce at support level marked 2 and finally broke the previous support which is now a new resistance. When a support is broken, it becomes a new resistance. Therefore we have a buy signal at the break of the new resistance.  An aggressive trader would take a trade as soon as candlestick breaks and closes above the resistance.

A confirmation is considered when the bearish candlestick breaks the support level and closes below for a downtrend  and when a bullish candlestick closes above the resistance level for an uptrend.

In short to trade aggressively;

  • Sell just after the close of the breaking candlestick below the support level.
  • Buy just after the close of the breaking candlestick above the resistance level.
  • Place your stop loss slightly above the support level or below the resistance and not on the support or resistance levels. You know why? Price can hit your stop out, bounces and continues to your direction.

2.The conservative way

With the conservative way of trading a breakout, you just need double confirmation to place a trade.

When price breaks a support or resistance line, it sometimes pulls back to retest these levels. This is when this kind of a trader warms up to catch his /her entry point. Like we said, “it sometimes not always.”

If this kind of a trader was to trade on the same chart above, let’s see what would have been his/her entry point levels.

From the chart above, the circled points show how price retested the support level after the break out. On our first retest we have a sell signal which was confirmed by the bearish engulfing pattern.

When you notice any candlestick pattern form on these levels of support and resistance, price has higher chances of taking the direction the pattern suggests. This is something that should not skip your attention especially when it happens on a support or resistance.

On the chart above,the formation of a large bearish candlestick after the engulfing pattern confirmed our entry as it closed below the support line. Stop loss would be slightly above the high of the bullish candle and your target would be the next support level.

After price has bounced of the second support line, it broke our new resistance which was previously a suport before a break out. This gave us  a buy signal but as a conservative trader, you take position only after price retest. The area circled indicates a retest on support.

If you can take a good look on our second retest, you will see a bullish engulfing pattern identified by the circle. The formation of the bullish engulfing pattern gave a strong signal for us to take a trade. The next bullish candlestick gave confirmation for our buy entry position. Stop loss would be set slightly below the broken support and take profit target to the next resistance level after your entry point.

Waiting for a pullback confirmation may save you from fake outs but it rarely happens. So you are likely  to miss out on some trades which are very swift in their movements as they breakout the support and resistance.

Now let’s look at the  second way to trade Support and Resistance;

Trading bounces on support and resistance.

 As we previously mentioned, price falls or rises approaching the major support and resistance levels, it is likely to do three things.

  • Hold and congest on support or resistance.
  • Break the support or resistance
  • Bounce back from the support or resistance level.

When price bounces back you can execute your trade on the confirmation candlestick at the bounce. You just decide to also bounce with it. Wait for confirmation candle to close before you give your entry.

Lets have a look on the chart below:

The above chart shows how you can trade support and resistance levels as price bounces off these levels. Like we said before, levels of support and resistance are considered price reversal/ bounce levels.

From the above chart, all reversal/ bounce points are identified with black circles. point 1 gives us the first price bounce  on the resistance 2 with a long pin bar and a bearish engulfing pattern. If we were to trade that, our entry would be at the close of the next bearish candlestick. As price rallied down, it found support below giving us a buy signal on reversal (Buy 1) on the support still with a  bullish candlestick with a pin bar. So our entry would be at the close of the next bullish candlestick. Come to points 3 and 4, they also indicate a bounce on the resistance 1.

Previously, we said that the strength and validity of a support and the resistance level is determined by the number of times price attempts to break through but fails.  Once you have identified a strong level you can buy on a support bounce and set your stops a few pips below or  sell on a resistance bounce and set your stop level a few pips above the resistance hence sell signals.

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