When the market moves up and then pulls back, the highest point reached before it pulls back is now resistance.
As the market continues up again, the lowest point reached before it climbs back is now support.
One thing to remember is that horizontal support and resistance levels are not exact numbers.
To help you filter out these false breakouts, you should think of support and resistance more of as "zones" rather than concrete numbers.
One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart.
Another thing to remember is that when price passes through a resistance level, that resistance could potentially become support. The same could also happen with a support level. If a support level is broken, it could potentially become a resistance level.
Trend Lines
In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys). In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks). There are three types of trends:
- Uptrend (higher lows)
- Downtrend (lower highs)
- Sideways trends (ranging)
Channels
To create an up (ascending) channel, simply draw a parallel line at the same angle as an uptrend line and then move that line to position where it touches the most recent peak.
To create a down (descending) channel, simple draw a parallel line at the same angle as the downtrend line and then move that line to a position where it touches the most recent valley.
- Ascending channel (higher highs and higher lows)
- Descending channel (lower highers and lower lows)
- Horizontal channel (ranging)
Trading support and resistance levels can be divided into two methods: the bounce and the break.
When trading the bounce we want to tilt the odds in our favor and find some sort of confirmation that the support or resistance will hold. Instead of simply buying or selling right off the bat, wait for it to bounce first before entering. By doing this, you avoid those moments where price moves so fast that it slices through support and resistance levels like a knife slicing through warm butter.
As for trading the break, there is the aggressive way and there is the conservative way. In the aggressive way, you simply buy or sell whenever the price passes through a support or resistance zone with ease. In the conservative way, you wait for price to make a "pullback" to the broken support or resistance level and enter after price bounces.
(See more) What is Japanese Candlestick?
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