The point at which a trend stops or makes a pause is a support or resistance, depending upon the direction of the move. If it is not confined to a singular point, and reverses from a series of points, in a vicinity, then it is a support zone or resistance zone. The higher highs, higher lows, lower highs and lower lows in a trend move are the support and resistance zone of the market. There isn’t any indicator in default as support and resistance indicator to identify the dynamic supports and resistances, which are created at unchartered territories. However, specific indicators functionalities can be extrapolated to a support and resistance indicator.
When the price is in a free fall state, it makes a pause or completely reverses its course of action at a certain point known as support. The demand will be higher than supply at support, and hence the price tends to turnaround its course of action. Simply put, support is any price point which prevents the price from falling further.
In the above hourly chart of USD/JPY, support is the point which acts as demand zone and resumes the bullish trend. The pair bounces off from each supportive point and creates a new high which validates the support.
How to identify support?
When the price reverses a bearish move, at a certain point three or more times, it can be designated as valid support. The number of times it has reversed from a certain point, the more robust the support is. A straight line is drawn connecting the bullish reversal points to identify it.
As the daily chart of EUR/GBP shows, the market bounces off from the point 0.83359, indicating strong demand. These kinds of strong supportive points are indeed the best entry points for long trades.
It is not always possible for the market to bounce back precisely from a single point. Instead, a range of price point supports the pair known as the support zone. The support zone is relatively difficult to comprehend on short time-frame charts. Longer time frames can spot the support zone with ease.
The above chart is a weekly chart of EUR/USD. The pair finds support at the range of 1.03500 to 1.06000. Since this happens during a long span of time, the EUR/USD pair was not able to maintain a single supportive point, rather a zone supports.
When the price is on the rise, it tends to make a pause or change its course of action at a certain point known as resistance. The supply will be more than the demand at resistance.
In the hourly chart of EUR/CAD, each time the pair makes a pullback, the supply rich points which revive the downtrend is the resistance. These points are good entry points for short trade.
How to identify a resistance?
A valid resistance point is the one which makes the price action pause or reverses its course of action at a certain point three or more times. The number of times it has reversed is directly proportional to its strength. A straight line can be drawn connecting the bearish reversal points to identify the resistance.
As indicated in the daily chart of USD/CHF, the point 1.00415 acts as the strong resistance. Each time it meets the point of 1.00415, it acts as a wall and instigates a sharp down move.
Similar to the support zone, the resistance zone identifies the cluster of resistance points amid fluctuations. The reasons for the price to be resisted by a bunch of points differ based on fundamentals. But, the occurrence is comparatively higher in long-term charts.
The price range of 1349-1366 acts as an active resistance zone in the daily chart of Gold. Its effort to break the area proved in vain. The bullion metal, at last, made a robust bearish move from the zone which only validated the resistance.
Support and Resistance Indicator (Advanced methods)
The price action strategy identifies the static supports and resistances easily. But the supply and demand vary dynamically at different instances and periods. It is difficult to locate these supply and demand zones which supports and resists price action using conventional methods. The indicators like moving average, Fibonacci tools and pivot points identify supply and demand zones at specific instances and timeframes, depending on the trend, and hence known as support and resistance indicator.
Moving Average as Support
A moving average supports the price in many instances. It helps in the resumption of a trend after a correction in a directional move. Therefore, the best entry points in a trend move are when prices are at the support zone around the moving averages.
The 100-SMA supports price action and holds the trend move. The 1-hour chart of EUR/NZD is a perfect example of the theory. Consequently, the pair makes a strong trend move, every retracement coincides with the 100-SMA. The trend revives on reaching the moving average.
Moving Average as Resistance
During a robust bearish move, the moving averages serve as the resistance. Both SMA and EMA can act as resistance. Moving averages resist pullback and serve as the supply prone zone in downtrends.
In the 1-hour chart of EUR/CHF, the zone in and around the 100-SMA resists the pull back and resumes the downtrend. In this case, moving average acts as a resistance zone.
Fibonacci Retracement and Extension
This is the best support and resistance indicator a trader can ask for. In an uptrend, the Fibonacci retracement points are the strong demand zones whereas the Fibonacci extension points are the supply zone (vice versa for the downtrend).
The Fibonacci retracement levels 0.236, 0.382, 0.5, 0.618 are strong supports in any directional move. They act as a good supply or demand zone depending on the type of the trend. Likewise, the Fibonacci extensions, especially the 1.618 point, resist (in an uptrend) or supports (in a downtrend) the price action. Human beings (traders are humans too) tend to react to the Fibonacci values and it plays, psychologically, a great part in a trader’s decision making. (Read more about humans and Fibonacci number here)
The above chart is a fine example of the Fibonacci indicator being a support and resistance indicator. The GBP/JPY pair, in a downtrend, makes pullback. The 0.5 retracement value of the previous trend move resists the price action strongly. Likewise, the 1.618 extension point upholds the falling price. Both these points were not significant points based on previous price action.
The pivot point is the best intraday support and resistance indicator. It indicates the supports and resistances for the day, based on the previous day’s movement. If you are an intraday trader, these values are of pivotal importance to you.
Role reversal – Perfect way to trade support and resistance
Whenever support breaks, it then resists the price action. Likewise, a resistive point supports the price action as the price makes a valid breakthrough. The role reversal spot is the best instance to enter into a trade.
When the price breaks out a supportive point, a trade should not be initiated spontaneously. The broken price point will be subsequently tested, and its role will be reversed to resistance. It is the perfect place to go long. The same applies to the resistive zone. It is undoubtedly the best way to avoid the trap movements.
In the above example, the point 0.90013 initially resists the price action. Once the pair breaches past the price value of 0.90013, it then converts itself to a supply zone.
The demand prone zone supports the price action. Likewise, the supply rich zone resists the price action.
The support zone is a good entry point for long trades whereas the resistive zones are ideal for short trades.
The strength of the support zone or resistance zone is directly proportional to the number of times it tests a certain point.
Moving averages, Fibonacci retracements and extensions can be extrapolated as support and resistance indicator.
A resistive point converts itself to a supportive point the as soon as the valid breakthrough happens. It is the best instance to initiate a trade. The vice-versa occurs with the supports.