Identifying Support and Resistance in Financial Markets

Defining Support and Resistance

Support levels represent price levels where a downtrend is expected to pause due to a concentration of buyers. Resistance levels represent price levels where an uptrend is expected to pause due to a concentration of sellers.

Principles of Identification

These price areas are identified by visually analyzing a chart to locate prior highs and lows where price has previously reacted. The more often price has reacted at a particular level, the stronger the support or resistance is considered to be.

Types of Support and Resistance

• Horizontal: Occur at specific price levels.
• Dynamic: Changing levels indicated by diagonal constructions.
• Psychological: Round numbers often act as psychological barriers.

Drawing Methods for Dynamic Levels

These are created by connecting a series of consecutive swing highs (for identifying potential resistance) or swing lows (for identifying potential support). At least two, and preferably three or more, significant price points are needed to create a reliable indication.

Validation and Confirmation

A valid area is confirmed when price bounces off of it multiple times. The steeper the angle of the diagonal lines, the less reliable the indication may be. Breaks above resistance or below support can signal potential trend continuations or reversals.

Using Volume to Confirm

Significant volume increases during bounces from potential support or rejections at potential resistance can provide additional confirmation of the strength of those areas.

Potential Pitfalls

Subjectivity in identifying significant highs and lows can lead to different interpretations. False breakouts can occur, where price briefly penetrates a level before reversing direction. Over-reliance on singular indications should be avoided; combine with other indicators for robust analysis.