A layman's guide to Support and Resistance levels

FOREWORD

In this thread, i would try with the best of my knowledge to explain the following questions as easily and briefly as possible.

1. What is a support level?
2. What is a resistance level?
3. What is their importance?
4. When and where to place Buy/Sell orders?

INTRODUCTION

Support and resistance levels are a critical part of trend analysis because they are used to make specific trading decisions. The fact that these levels flip roles between support and resistance can be used to determine the range of a market, trade reversals, bounces or breakouts. They help in identification of a trend reversal.

For example, you might identify an upcoming support level and decide to start buying the stock as it approaches the said support knowing that it will likely rebound higher. The support and resistance levels test and confirm the trends and should be closely tracked by every trader. These levels exist due to an influx of buyers and sellers at key junctures.

So, the question arises- what does support and resistance really mean?

What is a support level?

A support level is a level where the price tends to find support as it falls. This means that the price is more likely to "rebound" from this level rather than pierce through it. However, once the price breaks down this level, it is likely to continue falling until meeting another support level.

What is a resistance level?

A resistance level is the level where the price tends to find resistance as it rises. This means that the price is more likely to "bounce back down" from this level rather than break through it. However, once the price pushes above this level it is likely to continue rising until it meets another resistance level.

TRADE SETUP:

BUYING THE SUPPORT

The price gets rejected from the resistance level for a few times. Finally, after a good attempt the price manages to breakout from the resistance. Don't buy yet, wait for the retest since it can be a false breakout and you may end up losing your money. After a successful retest, open up your long positions. Make sure to lock in profits on the way up.

In the example above, you can see that the price tries to break the resistance 3 times before it finally manages to pierce through it. A person buying on the retest made a hefty profit of 166% from the breakout point to the peak point.

SELLING THE RESISTANCE

The price gets rebounded from the support level for a few times. After a few attempts the price finally breaks down of the support level. Don’t sell yet since it can be a false break down, wait for the retest. If the retest is successful, close your long positions on the breakdown point. Some may want to open short positions too.

In the example above, you can see that after 3 failed attempts to breakdown, the price finally pushes down from the support level on the 4th attempt. People closing out their longs on the breakdown point after the retest saved 52% of their capital from the breakdown point to the lowest point considered. Also, the shorts gained a good amount of 52% on this trade.

ROLE REVERSAL

A resistance level after a successful breakout turns into a support level and a support level turns into resistance level after a breakdown.

USEFUL TIPS

1. Avoid placing orders at these major points since there exists a lot of volatility around these points.

2. Take care to not place buy/sell order directly at these levels since there is a good chance of not hitting the exact levels. Use approximate margins for placing orders.

3. Never ever forget to use a stop loss if for an instance the trade doesn’t go as expected.

So, that is it from my side. If you find this article/information helpful, be sure to leave an upvote and share with all your friend.

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