Support and resistance levels are essential components of technical analysis, offering critical insights into potential future price reversals. These levels are frequently used by traders to reach their prop trading targets.

What is Support?

Support is a level on a market’s chart where the price tends to stop falling and bounce back up during a downtrend. When an asset is in decline but consistently halts and rebounds at a specific price point, this is identified as a support level.

When an asset reaches a support level, sellers are unable to push the price lower. Buyers step in, perceiving it as a good entry point, which leads to a price reversal.

Example:

• In a downtrend, AUDUSD drops to 0.6285 repeatedly but cannot breach it. This level acts as support.
• Support levels can also appear in an upward-trending market, presenting higher support points as the market moves up.

Support levels are visible on charts of any timeframe and are often referred to as a “base” or a “floor.”

What is Resistance?

Resistance is a level on a market’s chart where the price struggles to move higher and tends to fall back down during an uptrend. This level acts opposite to support.

When an asset reaches a resistance level, buyers are unable to push the price higher, and sellers take over, causing a price reversal. 

Example:

• In an uptrend, USDJPY rises to 151.95 repeatedly but fails to break through. This level acts as resistance.
• Resistance levels can also appear in downtrends, presenting barriers to upward movements.

Resistance levels are sometimes called an asset’s “ceiling.” When a market is “range-bound,” it means its price is oscillating between established support and resistance levels.

Importance of Support and Resistance

Traders frequently use support and resistance levels to plan their entry and exit points. If a support level has been tested but not breached multiple times, it might indicate a buying opportunity. Traders can open a long position near this support, anticipating a rebound. Similarly, a resistance level tested multiple times may offer a short-selling opportunity, expecting a price drop.

The more times a market bounces off a support or resistance level, the stronger it is considered. For instance, if USDJPY repeatedly fails to rise above 151.95, this level becomes a major resistance. Trader psychology often reinforces these levels, as repeated bounces off a level prompt more traders to place trades accordingly. 

Identifying support and resistance can help maximize profits or minimize losses when exiting positions. However, these levels are not absolute and can be broken, leading to significant market moves towards the next support or resistance level. This is where they can take advantage of “breakout trading”, by opening a position when the market breaks through a significant level and trading the ensuing move. 

Breakouts from support and resistance levels are more likely when price action builds momentum gradually toward these levels. In such cases, the market may not be apprehensive about a reversal, as the steady momentum does not raise immediate concerns. However, when the price moves quickly toward a support or resistance level, the increased momentum may cause the market to set a stiff barrier against it in anticipation of the forecasted support or resistance level. This defensive reaction can lead to a reversal, as the market absorbs the sudden price movement and reacts accordingly.

Major vs. Minor Levels

Not all support and resistance levels hold the same weight. We can view them as either minor or major:

• Minor Levels temporarily delay price movements within a larger trend, while
• Major Levels potentially stop and reverse a trend altogether.

Dynamic Levels

Above we have reviewed what are called “static” support and resistance, which restrict the price from going below or above a specific price point and may often be a place of trend reversal. It is important to note however that support and resistance do not occur only at the end points of the trend. Rather, the market can cross multiple such levels as the price advances or declines within the major trend. This is why some traders also keep an eye on the “dynamic” levels that may appear on the chart. 

Observing these levels often provides an opportunity to enter the market or add to an existing position with a pretty reasonable reward to risk ratio. To limit potential losses though the trader should always consider placing a stop loss order below the dynamic support or above the dynamic resistance.

Example of Dynamic Support

Example of Dynamic Resistance

Support Can Become Resistance

Support and resistance levels can switch roles based on market sentiment. For example, in a bear market, a support level can become resistance if the sentiment turns bullish. Similarly, previous resistance can become new support in a bull market. Observing how support becomes resistance (and vice versa) can provide valuable information for future price movements, aiding in strategy development.

Understanding these dynamics helps traders make more informed decisions, anticipate market movements, and refine their trading strategies.

For further reading you can visit our FPT Trading Academy​.