How to Trade Based on Support and Resistance Levels

Simply put, a support level is where the asset price stops falling, and a resistance level is where the asset price stops rising. However, traders need more information about support and resistance after these basic definitions before they attempt to make trading decisions based on these areas on the chart.

Using Trend Lines

Support and resistance levels are highlighted using horizontal or slanted lines called “trend lines.” If the price stops and reverses direction in the same price area on two consecutive occasions, a horizontal line is drawn to show that the market is struggling to move above that area.

In an uptrend, the price rises to higher peaks and higher troughs. In a downtrend, the price drops to lower troughs and lower peaks. Connect the peaks and troughs through the trend. Then extend this line to the right to see where the price may find support or resistance in the future.

Main and Secondary Support and Resistance Levels

Secondary support and resistance levels do not last long. For example, if the price is falling, it will reach a trough and then bounce back and start falling again. This trough can be identified as a secondary support area because the price stopped and bounced from that level. However, since the trend is downward, the price is likely to eventually drop through this secondary support level without much trouble.

Secondary support or resistance areas provide analytical insight and potential trading opportunities. In the example above, if the price drops below the secondary support level, we know that the downtrend is still in play. But if the price stops and bounces near the previous trough, there may be a range developing. If the price stops and bounces above the previous trough, we have a higher trough, indicating a potential change in trend.

Main support and resistance levels are price points that recently caused a reversal in trend. If the price is trending upward and then reverses to a downward trend, the price at which that change occurred is a strong resistance level. The point at which the downtrend ends and the uptrend begins is a strong support level.

When the price returns to a main support or resistance area, it often has difficulty breaking through and moving in the opposite direction. For example, if the price drops to a strong support level, the price is likely to bounce upward from it. The price may eventually break through the level, but it typically bounces off this level several times before doing so.

Trading Based on Support and Resistance

The basic way to use support and resistance in trading is to buy assets near support in uptrends or parts of ranges or chart patterns where prices are rising and sell/short near resistance in downtrends or parts of ranges and chart patterns where prices are falling.

It is helpful to isolate a long-term trend, even when trading in a range or chart pattern. The trend provides direction for trading. For example, if the trend is downward and then a range develops, preference should be given to selling short at the range resistance rather than buying at the range support. The downtrend tells us that short-selling has a better chance of making a profit than buying. If the trend is upward and a pattern like a triangle develops, preference should be given to buying near the triangle pattern support.

Buying near support or selling near resistance can be effective, but there is no guarantee that the support or resistance will hold. Therefore, it is essential to wait for some confirmation that the market is still respecting that area.

If
You would buy near support, wait for a consolidation to occur in the support area, and then buy when the price surpasses the highest point in that small consolidation area. When the price moves in such a manner, it teaches us that the price is still respecting the support area and also that the price has started to rise off support. The same concept applies when selling at resistance. Wait for a consolidation near the resistance area, then enter a short position when the price falls below the level of the small consolidation.

When buying, place a stop-loss a few cents (or points) below support, and when selling, place a stop-loss a few cents or points above resistance.

If you’re waiting for a consolidation, place the stop-loss a few cents or points below the consolidation when buying. When selling, the stop-loss is placed a few cents or points above the consolidation.

Upon entering a trade, set a target price for profit exit. If you’re buying near support, consider exiting before the price reaches a strong resistance level. If you’re selling at resistance, exit before the price hits strong support. You can also exit at secondary support and resistance levels. For example, if you’re buying at support in an upward trending channel, consider selling at the top of the channel.

In some cases, you may be able to extract more profit if a breakout occurs, rather than selling at secondary support/resistance. For instance, if you’re buying near the support of a triangle within a larger uptrend, you might want to hold onto the trade until the triangle breaks resistance and continues up.

Old support can become new resistance and vice versa. This isn’t always the case, but it works well under very specific conditions, such as a second breakout opportunity.

False Breakouts

Prices of assets often move a little more than we expect. This doesn’t happen all the time, but when it does, it’s called a “false breakout.” If our analysis shows that there is support at $10, it’s very likely that the price will drop to $9.97 or $9.95 for example, and then start to rise again. Support and resistance are areas, not an exact price. Expect some variance in how the price behaves around support and resistance. It’s unlikely that the price will stop at the exact price as it did before.

False breakouts are excellent trading opportunities. One strategy is to actually wait for a false breakout to occur, and only enter the market after it happens. For example, if the trend is up and the price is returning to support, let the price break support and then buy when the price starts to rise again above support.

Similarly, if the trend is down and the price is returning to resistance, let the price break resistance, then sell when the price begins to drop below resistance.

The downside of this approach is that a false breakout will not always occur. Waiting for
Source: https://www.thebalancemoney.com/how-to-trade-based-on-support-and-resistance-levels-4043477