Do you want to learn one of the most powerful trading concepts in existence? One that can transform your profit potential and turn your part-time hobby into a real money-making venture? Learning the basics of support and resistance can do that. That’s because these all-important charting zones can tell you all sorts of relevant information about the direction of price. Not only that, when you’re able to identify where the support and resistance areas are located, you’ll know precisely where to set stop-loss and entry points. Before you hang your full-time, professional trader’s sign on the office door, it’s best to know four basic facts about support and resistance zones.
It’s a Zone, Not a Line
The key word is zone, not line. Read a few articles about the topic and you’ll quickly discover that those who discuss SR mention the higher point, resistance, and the lower point, support, as lines. In fact, they are zones that encompass a range of prices on both the upper and lower sides of the range. This seemingly unimportant concept makes a huge difference when you set out to determine stop-loss and entry prices for a particular security.
More Testing Mean Greater Weakness
When those engage in share trading, it’s common to watch the price action for a day or two before making a move. That’s smart, but what can you learn by watching? See if the price of a security bounces off a high range, seemingly unable to break through. That’s the resistance zone. The principle is that the more times price bumps into and fails to bust through, the weaker the resistance zone becomes. It’s sort of like a boxer who takes repeated punches to the chin. Each one weakens his chin a bit more, until it finally gives way. This testing process does the same thing to support zones. If prices keep falling down to a specific range and bounce back up numerous times, then that S zone is getting pretty weak and is likely ready to cave.
Where to Park Your Stop and Entry Points
There’s a very old, and incorrect, myth about how to set stops and entries in that it’s best to set stop-losses just above the R area and to set entry points below support prices. The corrected version is that you can set stops just below R, and set entries just above S. Tinker with this concept, both the myth and the corrected version on a price chart of your favorite security and you’ll understand the logic.
SR Zones are Not Static
Above, we noted that SR is not a line or point but a zone. Keeping that in mind, note that zones change over time, mostly in response to moving averages. For instance, today’s S zone for stock ABC might be, with R significantly above. Plot the 200-day moving average (or a 50-day if you prefer), and see what happens to those zones. They move up and down, forming a sort of channel you can use to predict where SR will be a day, week, or month from now.