Support_and_Resistance.jpg

Support and resistance

Course Price

Free

Course length

60 Mins

Sebas compact.jpg

Sebastian
Blancke

Instructor

Welcome to my Masterclass.

In this lesson you will learn what the foreign exchange market is all about and how we are able to take advantage of the worlds biggest exchange.

Floors and ceilings

Support and Resistance is one of the most used techniques in technical analysis. It identifies price levels where historically, price reacted by reversing. Price behaviour at these levels can leave clues for future price behaviour. Support and Resistance levels can be identifiable turning points, areas of congestion or psychological levels (round numbers that traders attach significance to). The higher the timeframe, the more relevant the levels become.

Now before you scroll down, look at the chart directly below. Can you spot a level that really pops out and where price has bounced off from multiple times?

Support & Resistance naked.png

Horizontal Support and Resistance

First, let’s define Support and Resistance:

  • Support – Area on a chart with potential buying pressure

  • Resistance – Area on a chart with potential selling pressure

As you can clearly see, price has bounced off the 0,87 level from both below this level (resistance) as well as from above (support). It also happens to be a "round number" which often times acts as additional mental support and resistance level.

Support & Resistance zoomed.png

The more times Support or Resistance (SR) is tested, the weaker it can become 

The market reverses at Support because there is buying pressure to push the price higher. The buying pressure could be from Institutions, banks, or smart money that trades in large orders.

Imagine this:

If the market keeps re-testing Support, these orders will eventually be filled. And when all the orders are filled, who’s left to buy?

Here’s what we mean…

Support & Resistance.png

How to know when support for instance is getting weaker? It in fact is very easy to see once learned the language of price-action.

Look at the image above. Every time our SR line is reached, price shoots back up, right? However, right in the middle you can see that price wanted to go higher than it did before (last 3 highs). When it pierced to new highs, price fell immediately back to previous high levels. This tells us that the bulls were unable to sustain prices it this all time high level. After that the bears took control and the SR line was tested once again.

As we'd expect price rejected this SR level and shot up. However, and this is the tell tale, price was unable to reach the previous high. This tell you that bulls are losing steam. First they could not sustain prices at the all time high level, and now they are unable to get prices back to the previous high. 

So what happens next? Price drops again and even breaks through our SR line. This time however the bears cannot hold price down, and the bulls once more push prices up. But what happens next? Can you spot it? Indeed, the bulls are once more unable to reach previous highs (which were already lower than the high before that). This is the sign that the bulls are losing this fight, and that our SR area will be broken to the downside. And this is exactly what happened.

Level not clean-cut. What does it mean?

When a Support and Resistance level on your chart is at an even number, such as in the example above (@ 0,87 cents), price usually seems to pretty precisely react to that level. However there are also SR levels that are not as cut-clear.

A word of advice, if we zoom out our chart and we cannot identify a clear level (or zone) where price has reacted to, there is no level. Many rookie traders tend to overcomplicate their charts with levels that we perhaps, kind of, 1 or 2 times rejected in the past, but the levels do not completely align.. STOP. Only when we can identify a level that price rejected to with a massive move to the upside or downside, the level is valid.

However you might find an area on your chart that price genuinely reacted to and is not just one horizontal line (level), but it might be 2, 3, 4 lines right next to each other. In this case we call this a Support and Resistance "zone".

Sometimes you might find a level that is kind of rejected, but the level is not horizontal. In this case you could have identified a "trend line", which is also a Support and Resistance level, just not horizontal. And in many cases you can spot a second "trend line" just to the opposite side of price. This means you have identified a price-action pattern which consists out of two trend lines and can give you some clear signs to what price is about to do. But more about price-action patterns in the chapters that follows.

Let's now focus on that is means if you've identified a level and price 'undershoots' or 'overshoots'. What does this tell you about what other traders are thinking and doing?

Support & Resistance under-overshoot.png

Price “undershoot” and you missed the trade

This occurs when the market comes close to your SR line, but not close enough. It reverses back into the opposite direction. And you miss the trade because you were waiting for the market to test your exact SR level. This happens and means the trade was not good enough. We never let our FOMO emotion take over in such a situation. Either price comes to our SR level and confluence factors (entry criteria) for an entry are being met, or we don't take the trade. When price fails to reach our SR level, we do not enter the trade. Even if all other confluence factors are met.

Price “overshoot” and you assume SR is broken

This happens when the market breaks our SR level and we assume it’s broken. This is way of thinking, and acting on it by taking a long position once a support or resistance level is broken, is called 'break-out trading'. And although it is completely possible that price indeed has broken resistance and is now going higher, it could also be a trap.

Imagine this. Smart-money (investment banks, hedge funds, brokers, investors or large size traders) are all seeing what we are seeing. Namely a solid resistance level, in our case at 0,96 cents. Every time price hits this level it declines back to support (0,87 cents). However smart-money wants price to go lower (for whatever reason). Since smart money trades in sizes that can actually manipulate price, can you guess what they could do?

When price come close to our support level once more and starts to decelerate, most traders think to themselves.. here we go again, back to support for a nice profit. However this time they are mistaken. Just as the majority of traders are tagged into their short position, smart-money injects a massive amount of buying pressure into the market and push price up hard.

At this point all short traders are in a losing position and are feeling the pain. They either have placed a stop-loss order above the previous highs that are now about to be broken. Or they have not placed a stop-loss order and are pulling their hairs out, while trying to think what they should do. Price continues to climb and sure enough price is now trading above the last 'swing-high'. As a result the majority of these traders are now tagged out of their losing long position, and have sold their long position for a loss. Hence price comes down again with momentum to the downside.

As price breaks the SR level to the downside once more, short sellers jump on the band wagon to ride the wave down. Such a failed attempt to break above SR is the reason why break-out traders typically don't make it as traders in the long run. Their capital is used for liquidity by smart-money.

We will teach you how to differentiate between a fake break-out and a real break-out. Of course real break-outs can occur and if they do, we can capitalize on them by deploying our 4th strategy which you will learn about later on in this masterclass.

I guess by now you think that trading is beginning to look like some sort a game, right? A game where you have to read your opponents mind in order for you to determine what your next move is going to be. Sort of like playing chess. And you are right. Is it just like playing chess. Only in our game we can actually reed the opponents mind, as is it written in price-action on our charts. It is a language that you will learn and once mastered, becomes second nature. 

Trend Line Support and Resistance

When you look at any chart you have probably seen that price does not move straight up or down, but that is moves in a zig-zagy way when it is trending. 

Support & Resistane Trend Line.png

As you can see, price is ascending from our bottom left corner, to our right top corner of our screen. Price is making a big move up (which is called a "run" or "impulse") and then pulling back slightly (which is called a "pullback" or "correction").

Why does this happen do you think? Why does price not go up in one straight line? Well, if we bought the NZD (New Zealand Dollar) / CAD (Canadian Dollar) at the bottom left of our screen, it would have been in a very nice profit after a few weeks when price started to decline after the first impulse up.

And if we would zoom out of our chart, we would probably be able to see some kind of previous SR at some of these levels when price reversed short term. When we would approach these levels, we would think to yourself "well, this is a good time to exit and take some profit". And this is exactly what happens. Traders know that price does not shoot straight up without ever coming down. Hence they take their profits along the way and certainly around clean SR levels.

Now we have mainly taught you about traders taking profit or opening a new position at SR, but there a many other traders looking at completely different set up criteria for such decisions. There are traders that put their focus on fibonacci levels, traders that trade supply & demand, or traders that only trade off indicators such as the Ichumoko cloud indicator and many, many other types of traders. You don't need to know about any of them for now, just know that there are other ways to approach the market and make money. However the majority of traders will look at support and resistance, and not just horizontal SR.

Here's what I mean.. Look at the chart above once more. With every move up, which at some point will reach its peak, price retraces in the opposite direction. Such a peak in price is called a "swing high". With every move down, which at some point will reach its low, price will come back up. Such a trough, or valley in price is called a "swing low".

But, how do we know if price has actually made its highest or lowest point? Perhaps the low you are now seeing will be broken in a few days and the swing-low you identified was in fact not the lowest low. This way of thinking is completely correct, and that is why we have a very clear way of knowing when a swing high or swing low can be identified as such.

Let's zoom into the first run up and the pullback that succeeds. 

Support & Resistance Swing Low.png

Although at this point in time you can clearly see the dip, or low in price, however it is not yet confirmed. Price could easily trickle its way down from here and make an even lower low, right? It is only confirmed when price breaks the most recent swing high. Only at that time the lowest point in the pull back can be labelled as a swing low. So let's see what happens next..

Support & Resistance Swing Low confirmed

The horizontal blue line is drawn at the top of the most recent swing high. After we identified our expected swing low, price actually fell again before breaking the swing high. Once price breaks the recent swing high, all our previous throughs in price (swing lows) are now confirmed. Not only is the swing low confirmed that we high lighted, but also the swing low that followed, before price took out our swing high. This last low in fact is now our most recent swing low.

In an uptrend, swing lows are confirmed when price breaks the most recent swing high.
The last swing low, just before price break the swing high becomes the latest swing low.

In our example:

Support & Resistance Swing Low 1 confirm

As you can see, the swing low on the right is now our most recent swing low. And so we continue..

Support & Resistance  Swing Lows.png

In fact runs and pullbacks often happen in such a ratio to each other that we can cleary see that price is rejecting some kind of sloped trend line. Take a look at price in this uptrend, can you draw a line connecting the swing lows and a line connecting the swing highs?

Support & Resistance Trend Lines hidden.

In fact, when you are able to connect two swing lows and extend the line that you drew, price will most likely come down at some point and reject the trend line we've just drawn as support for the 3rd time. Same goes for a trend line where we connect our swing highs..

Look at the chart below. As you can see, once we connected the swing lows with a tend line and extended it, price came down and rejected it for the 3rd time. Same goes for the upper trend line.

Support & Resistance Trend Lines visable

When the market is trending, price will impulse down or up and then pullback a certain amount. In trending markets the ratio between these impulses and pullbacks are frequently very consistent. This means that after every pullback, the generated swing highs and lows can be connected by a sloped so called 'trend line'. We draw our lines at the extremes of the swing high and lows (at the wicks of the candles).

Once two swing lows are co

nnected by a trend line, there is a high probability that when price reaches the trend line for the third touch, price will reject the line and continue its trend. However a trend line is not confirmed until it has 3 confirmed touches. As you can imagine, any two swing highs and lows can be connected. This does not mean it is a confirmed trend line. Trend lines for the majority work because many other traders see them as well and act on their existence. Although trend lines with just two touches are not confirmed trend lines, they are valid and we do draw them in to see what price does around these levels. 

In an uptrend we draw the trend line under price as it is used as support.
Why? As we are in an uptrend, we are looking to trade with the trend and therefore for buy opportunities. When price pulls back to the trend line as possible support, this offers great value for a buying. 'Good value' means you get into the trade at a good price, since price has come down significantly and you expect it to go up again.

In a downtrend we draw the trend line over price, as it is used as resistance.
Why? When we are in a down trend, we are looking to trade with the trend and therefore for sell opportunities. When price pulls back to the resistance line as possible resistance, this offers a great sell opportunity at value.

Let me show you with an example on Copper:

Dynamic SR Copper TrendLine.png

As we can see price rejects the trend line (support) perfectly, but eventually the trend line will be broken and depending on the time frame, price will continue is overall higher timeframe direction. What this means we will explain in the chapter 'multi time-frame analysis'.

Although the example from above is a very clear example of what a a trend line looks like, in the real world trend lines are not always this 'pretty'. Once you experience the market and watch it evolve, your ability to spot possible trend lines will increase. An example of a trend line that is still valid but a little harder to spot:

Dynamic SR GBPJPY TrendLine.png

This trend line only has two touches and therefore is not confirmed. This means we cannot place a trade from it (in this example a short trade). However we do use trend lines with only two touches to confirm the end of a pullback. What this basically means is, that after an impulse to the upside for example, price will usually pullback creating two lower lows and two lower highs. Once the last lower high is broken to the upside with momentum we continue the larger trend to the upside. We will dig deep into this in our chapter 'chart patterns'.

When we are able to draw a support line under price and a resistance line over price, and these lines are parallel to each other containing price within these levels, we have drawn a "channel". What this pattern means, we'll discuss in the next chapter.

For now just remember that trend lines need to have 3 touches to be confirmed and have any significance for us to trade from it. We draw trend lines with just two touches to see how price reacts to the trend line when it reaches it for the third time. We also use trend line as a possible confirmation for the pull back to end, and price to break out the trend line with momentum, to resume the overall trend.
 

Dynamic Support and Resistance

In the chapters above, we taught you how to identify Support & Resistance levels that are fixed (static). But Support and Resistance levels can also change over time, otherwise known as, Dynamic Support and Resistance.

Dynamic Support and resistance levels evolve with price. They are formed by calculating past price data and projected into the future. Indicators fall into this category. And although there are thousands to choose from, only a hand full can only help us make smarter trading descisions. The most used dynamic support SR indicator is the Moving Average. 

A 'Exponential Moving Average' is one of many types of 'Moving Averages' (MA's) and what this exactly means we will explain in the chapter 'Indicators'. For now just remember that the 12 and the 50 EMA are the most respected dynamic moving averages in the forex market. From extensive testing over decades of data, we isolated these two MA's as most reliable when the market is trending.


Moving average as dynamic Support / Resistance

For our strategies we only use two moving averages:

  • 12 Exponential Moving Average (EMA)

  • 50 Exponential Moving Average (EMA)

The 12 EMA is used as an entry point ,and the 50 EMA is used as a stop loss level. What this means and how it relates to our strategies, we will dig deeper into in our 'Strategies' chapter later in this masterclass.

Below you can see and example of price respecting the 12 EMA perfectly. The orange line is the 12 EMA, the red line is the 50 EMA.

Dynamic SR 12EMA.png

This concludes the chapter about support & resistance. I ties into trend lines and price patterns, that consists out of 2 trend lines, which we will explain in detail in the next chapter.