How to identify and draw Support and Resistance lines ?
Discover fundamental concepts about support and resistance in the third installment of our comprehensive series
In our previous articles we have discussed in candlesticks chart patterns about the entry, stop loss on the basis of the chart patterns. However, we did not clearly explained about the target price which is very confusing subject to most of the traders specially for the beginners. Now we will explore this subject in an easier way in today's post Part III of fundamental concepts of support and resistance.
When you initiate a trade you must have a logical target where you will book profit if the trade moves in your favour.
Target in a logical way means a good risk to reward ratio. The best way to identify the target price is to identify the support and resistance levels. The support and resistance are the most valuable points on chart that attracts the maximum participants (Buyers and Sellers).
Support is an area on your chart with potential buying pressure. That means support price attracts more buyers than sellers.
Similarly, resistance is an area with potential selling pressure. That means resistance price attracts more sellers than buyers.
Understanding the support level is an easy task. The support on chart is that level that prevents the price falling further. The support level is a price point on the chart of a stock or index where we expect a maximum demand or buying pressure coming. As soon as the price falls to the support level it bounces back.
The support level is always below the current market price level. First the price falls till the support, then consolidates, then absorbs all the demand and then bounces back to the upwards. This support level sometimes acts as a buying point.
Above is the chart of Hindustan Unilever. The horizontal line is the support line marks at 2400. On the chart which is below the current market price of 2627. Let us imagine a bearish pattern on the chart happens, then what will be the trade plan? Sell at 2627 stop loss at 2700, target can be the support that is 2400. Support at 2400 signifies that there is a probability of an excessive demand will emerge.
Excessive demand makes buying pressure. Buying pressure pushes the price higher.
So, if a trader creates a short position he can look at support point as his target of profit or can exit the trade if he is long.
Resistance on a chart is that point of price that prevents to rising further.
In simple language, the resistance level is a price point on the chart of a stock or index where we expect excessive supply on selling pressure coming. The resistance point is always above the current market price level.
First, the price rises up to the resistance level, then consolidates, then absorbs all the supply and then starts to fall. The resistance sometimes acts as a selling point.
Below is the chart of Asian Paint, The horizontal line marks at 2908.90 on the chart is the resistance level. This level is higher than the current market price of 2760.90
Let us, imagine a bullish pattern happens on the chart. What will be the trade plan as per the bullish formation? So we go for a long trade.
Entry is 2760.90, stop loss we will keep at 2700 and the target will be the resistance level of 2908.90.
The resistance of 2908.90 indicates that there is an excessive supply. Excess supply will intensify selling pressure which will pull down the price lower. So, a trader can make a long position with a target of the resistance level or may exit any long position at the resistance level.
Identifying support and resistant price points is extremely simple. The process is same for both support and resistance. If the current market price is above the identified line it is called a support. If current market price is below the identified horizontal line it is called a resistance.
How to draw Support and Resistance accurately?
- After learning about support and resistance we have to implement it to our trading, for this we have to make and draw S/R lines perfectly to make better trading decisions. How to do it correctly? First, zoom out your charts after scrolling so that you can see the big compressed picture of the chart.
- Secondly, draw the most clear levels in such a way that those levels have the strongest reaction zones.
- Thirdly, you have to adjust your levels on the basis of most number of touches so that you can get the 'Bright spots' on the charts.
After doing the above things follow the step below:
Step 1: Include data points - If you want to identify short term Support and resistance.
Include at least 5-6 months data points. If you look for long term support resistance you should consider 12-18 months data points. Short-term S/R is useful for intraday and BTST trade. Long-term S/R is useful for swing trade.
Step 2. Now you have to identify at least 3 price action zones.
Price action zones are those ‘bright spots' on the chart where the price may react to one of the following characteristics:
- Pauses to move up farther after short upward rally.
- Pauses to come down further after a short downward move.
- Makes sharp reversals from that particular points.
Here are three charts that explain about 3 sequences:
Below chart shows with the circled points that the price takes pause after a short upward rally
Below chart shows with the circled points that the price pauses to come down further after a short downtrend move
In the below chart the circled points indicate sharp price reversals
Step 3: Arrange the price action zones in a straight line.
If you watch a 12 months chart you will watch many price action zones. But technically you require at least 3 price action zones that must be at the same price level. You need the price action zones to be arranged at same price level as shown below.
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| price action zones to be arranged at same price level |
You must remember that when you identify price action zones make sure that there must be well spaced gap in time. The more time-gap between two price action zones the more powerful is the S/R points.
Step 4: For better trading decisions you have to identify the current market price point.
On the basis of current market price it is easier to mark the support and resistance:
- If the current market price is above the identified line, then it is a support
- If the current market price is below the identified line, then it is a resistance
Conclusion: In technical analysis there is no guarantee of anything else. Same is the case of support and resistance. We don't know whether the price will always respect the S/R lines or not. These are only indicative of probable price actions. So, one should keep in mind that this is only a possible measurement of an event that happens on the basis of some specific patterns formed as a matter of probability. Taking into consideration the past price action data we identify and draw S/R lines so as to implement on our trading going with the belief of the basic first rule of technical analysis--"History tends to repeat itself". If you want to know our personal experience in this context we will tell you that if you can draw S/R lines correctly and logically these areas are generally respected.
Disclaimer: The information provided on MoneyWiseMind is for educational and informational purposes only. It is not intended to be financial advice, and you should not rely on it as such. Before making any financial decisions, you should consult a licensed financial advisor.
