Disclaimer: The opinions expressed here are for general informational purposes only and are not intended to provide specific advice or recommendations for any specific security or investment product. You should never invest money that you cannot afford to lose. Before trading using complex financial products, please ensure to understand the risks involved. Past performance is no guarantee of future results.
From a price action perspective, the most important skill to being profitable is being able to identify dynamic support and resistance zones. This is the foundation of trading and the most important skill to master. You don’t want to be the one buying the top and selling the bottom.
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Following up on chapter 1, support and resistance zones are areas where the price “reacted” in the past and there is a (more or less) high possibility of it happening again. Trading opportunities arise in these areas as many traders have their eyes on them. This psychology is what we are after, we need to figure out what other traders are focusing on. Something worth noting is that when price breaks a resistance, that resistance often becomes a support zone and vice-versa.
We call these support and resistance zones because there is a high probability of an increase or decrease in the price when it reaches these zones. A ‘price bounce’ is a trading concept that is used to describe the following: A strong reaction by traders as price reaches a certain point, typically seen as strong increasing volume by either buyers or sellers, quickly driving price away from the support and/or resistance zone. By looking at a chart it’s possible to draw a vast number of support and resistance points, many of which are not ‘valid’ and result in false signals. The difficulty is figuring out which points are reliable.
Inside the support and resistance zones
In these zones, two things usually happen. When the price is approaching a support, the ‘sellers’ or traders who’ve been shorting the asset are considering closing their positions as they often assume there will be buying demand which might cause a reversal. A previous seller can become a buyer. This double action of sellers closing positions and buyers stepping in can cause the price to reverse around these zones. The same applies to resistances, in this case traders who are long on the asset will consider closing their positions and sellers are looking to sell their positions. Also known as, an increase in supply which can drive down price. Trying to summarize this: A combination of price development and volume development is a way for the market to show its hand.
It’s risky to jump into a trade every time the price reaches a zone, you risk responding to weak supports that will not hold. It’s important to wait for confirmations if you want to minimize this risk. Meaning, you wait for the market to react. We need to remember that the market always shows its hands, giving us indications of what it wants to do. We need to learn to read the signs correctly and impartially. You could say by waiting on confirmations you’re sacrificing some possible short-term return. Exchanging it for a reduction in risk and if executed well: a more reliable long-term return.
If you missed Chapter 1 follow this Link
Continue to Chapter 3 where you will learn how to plot support and resistance zones and lines.