My trading system relies heavily on the Support and Resistance concepts. In fact, every successfull trading systems rely on these concepts I guess.
There are some variants like the Supply/Demand zones, BUY/SELL areas, … But the reality is that the price is moving along and depending on certain levels.
The existence of this type of level can be explained by a bunch of reasons. This topic alone would deserve an in-depth article. But the main idea to remind here is that the support and resistance are the consequence of the psychological nature of the moving price. The price moves depending on the order flow, which is defined by the supply and demand of human beings. Yes, there are plenty of robots on the Forex but they are defined by men (and women).
The price properties cannot let him go anywhere on a chart and cannot get any arbitral value. There are rules. This information is true not only in the trading World but in every sectors where a price is involved (cars trading/leasing market, fast-food hamburgers, charity, …).
To find a heavy, steady, reliable trading system, we have to notice and exploit the raw properties of the price movement. Thus, the trading system will be able to make money all over the time, consistently.
The support and resistances areas are one of them.
We can start by staring at an aleatory Forex chart, the AUDUSD Daily of the previous year :
What we can see here ? In fact… nothing. We see the AUDUSD price going up and after going down during 2014. It’s easy to notice that the price is not moving in a straightforward way.
It didn’t go from 0.8700 to 0.9500 directly. It gone there by several steps. Ho, the 0.8700 and 0.9500 are round numbers, funny ? Maybe another price property…
Except these obvious statements, I can’t see anything else. Maybe, we could do something to have a better look to the chart.
When the point of view is not clear on something, no matter what, it’s always interesting to step back. Wider is the point of view, better is your perception. Let’s do it with our chart and unzoom a little bit :
Hey ! Now I can see something. In fact, we can see a lot of things. Several areas can be identified on this chart. Some of them made the price react really quickly and others made the price to stagnate around. The price was not able to stay 1 or 2 days in a row in some “hot” spots.
It’s really important for a trader analyzing his chart being able to cut out the different areas and locations. More you will spend time in front of chart, more quickly you will be able to find them. The price is always doing the same infinitely. Like the humans.
Here are the obvious hotspots we can identify and the zones making the price accelerate or stagnate :
We can do something really instinctive : link the hotspot together by drawing horizontal lines. We can notice other hotspots where the price interacted :
These are Support and Resistance. That’s all. You can see them everywhere, on any chart, on any market, on any timeframe. These levels have one main ability : it doesn’t leave indifferent the price action. Moreover, we can notice an interesting aspect of the price. It bounces on these levels, go through them, break them but it always stick to them in a variable period of time. It’s easy to see that the price is touching these areas several time before leaving them. Here is another raw price property : the price is viscous. It moves along the charts like melted chocolate.
The Support and Resistance areas materialize the history on the charts. These levels symbolized by horizontal lines are hit again, again and again during the life’s price.
In order to draw these lines in an efficient way, you only need to look at the left of your screen to find the levels. Here is the map of the AUDUSD life :
This is a monthly chart. You have all the currency movement on it since its birth. All the levels are heavy and full of sense. The price cannot approach them without having big reaction. By reading the history of the price and drawing the Support&Resistance levels, you can predict the behavior of the price hitting them. Like any other human activities, the previous events, the past, the history is in the people mind and influence the coming behavior. Draw it and foresee it.
An easy way to display these levels is to use the line chart mode on Metatrader :
Thus, the levels become really obvious to identify. When the price will approach them, expect strong reaction. We can see yet another internal property of the price on this line chart. The price can play the role of a “pincer” when it passes through a level. Keep the following picture in mind and go look at your live charts, you’ll see it everywhere. Focus on the green spots :
Let’s do it on the AUDUSD Weekly chart. Here is the zoomed upper-right corner of the previous AUDUSD Monthly chart:
The price stickiness is relevant here. The price turn around, bounce and leave this heavy Monthly level on the Weekly chart.
In case you didn’t notice the discreet red arrows on the previous picture, the following price movement was 100% predictable. Let’s zoom again on the Daily chart this time:
Market magic, the red candle appearing on this accurate zone is called an engulfing bar (or outside bar, or big shadow, or whatever) the 10/23/2013. Of course, I took this sell trade because the probability for the price to go to the south was around 0.8-0.9.
This is high probability setup relying on the S&R concept. We have the first rule of our system : only take trade when the price is in these zones.
Price Action properties noticed here :
- The price can’t move in a straightforward direction
- The price is hitting Support & Resistance areas endlessly
- The price is viscous. It will stick to the Support & Resistance areas (interesting setup : “pincer” pattern)
The next step is to identify the repeatable pattern on these levels and see if we can take advantage of it to make money in a secure way.