Introduction to the Stock Market_3. Support and Resistance Levels

Lesson 3: Support and Resistance Levels

What is support and resistance?
Support and resistance levels are horizontal price levels that typically connect price
bar highs to other price bar highs or lows to lows, forming horizontal levels on a price
chart.
A support or resistance level is formed when a market’s price action reverses and
changes direction, leaving behind a peak or trough (swing point) in the market.
Support and resistance levels can carve out trading ranges like we see in the chart
below, and they can also be seen in trending markets as a market retraces and
leaves behind swing points.
Price will often respect these support and resistance levels, in other words, they tend
to contain price movement, until of course price breaks through them.
In the chart below, we see an example of support and resistance levels containing
price within a trading range.
Note that in the chart below, price eventually broke up and out of the trading range,
moving above the resistance level, then when it came back down and tested the old
resistance level, it then held price and acted as support…

The other primary way support and resistance levels are created in a market, is from
swing points in a trend.
As a market trends, it retraces back on the trend and this retracement leaves a
‘swing point’ in the market, which in an uptrend looks like a peak and a downtrend
looks like a trough.
In an uptrend, the old peaks will tend to act as support after price breaks up past
them and then retraces back down to test them. In a downtrend, the opposite is true;
the old troughs will tend to act as resistance after price breaks down through them,
then retraces back up to test them.
Here’s an example of a market testing previous swing points (support) in a
downtrend, note that as the market comes back to test the old support, the level then

behaves as ‘new’ resistance and will very often hold price. It’s wise to look for an
entry point into a trend as it comes back and tests these previous swing points (see
pin bar sell signal in chart below), because it’s at these levels that the trend is most
likely to resume, creating a low-risk / high-reward potential:

How to trade price action signals from support and resistance levels
Support and resistance levels are a price action trader’s ‘best friend’. When a price
action entry signal forms at a key level of support or resistance, it can be a
high-probability entry scenario. The key level gives you a ‘barrier’ to place your stop
loss beyond and since it has a strong chance of being a turning point in the market,
there’s usually a good risk reward ratio formed at key levels of support and
resistance in a market.
The price action entry signal, such as a pin bar signal or other, provides us with
some ‘confirmation’ that price may indeed move away from the key level of support
or resistance.
In the example chart below, we see a key level of resistance and a bearish fakey
strategy that formed at it. Since this fakey showed such aggressive reversal and a
false-break of the key resistance, there was a high-probability that price would
continue lower following the signal…

The next example chart shows us how to trade price action from a support level in an
uptrend. Note that once we got a clear pin bar buy signal, actually two pin bar signals
in this case, the uptrend was ready to resume and pushed significantly higher from
the key support level.

The next chart example show us how sometimes in trending markets a previous
swing level will act as a new support or resistance level and provide a good level to
focus our attention on for price action entry signals.
In this case, the trend was up and a previous swing high in the uptrend eventually
‘flipped’ into a support level after price broke up above it. We can see that when

price came back to retest that level the second time, it formed a nice pin bar entry
signal to buy the market and re-enter the uptrend from a confluent level in the
market.

Finally, the last chart we are looking at is an interesting one. Note the swing low that
occurred in the down trend on the left side of the chart. You can see how this level
stayed relevant months later, even after the trend changed from down to up. It first
acted as a resistance level after price broke down through it, but once that resistance
was broken, we had an uptrend form and then after that, that same level acted as
support, and that’s where we see the fakey pin bar combo signaling the chart below:

Tips on Support and Resistance

● Don’t get too carried away with trying to draw every little level on your charts.
Aim to find the key daily chart levels, like we showed in the examples above.

● The horizontal lines of support or resistance that you draw won’t always touch
the ‘exact’ high or low of the bars it connects. Sometimes, the line will connect
bars slightly down from the high or up from the low. The important thing to
realize is that this is not an exact science, instead it is both a skill and an art
that you’ll improve at.

● When in doubt about whether to take a particular price action entry signal or
not, ask yourself if it’s at a key level of support or resistance. If it’s not at a key
level of support or resistance, it might be better to pass on the signal.

● A price trading strategy, such as a pin bar, fakey, or inside bar strategy has a
significantly better chance of working out if it forms from a confluent level of
support or resistance in a market.