Why is marking support and resistance levels so important?
Do you struggle with the process of marking your support and resistance levels? The process can be one that confuses lots of traders but in this article I will try to break down the technique I use to mark my key support and resistance levels, to hopefully get you to start marking these very important levels as accurately and consistently as possible.
So why is it so important to be able to mark our support and resistance levels properly? Well, I believe the foundation for any solid trading strategy is the ability to know where to find the best high probability trades and this means knowing exactly where the best levels are to go hunting.
We know that the markets have a tendency of repeating themselves and this can be seen on any chart. The reason for this is due to human participation and human nature causing price to react and repeat itself over and over again. If price reacts very strongly at a certain level on a chart, the chances are very high that it will react there again in the future. This repetitive nature of the markets allows us to mark key levels on the charts in the knowledge that price will repeats itself and may produce a valid trade setup.
Learning how to select the correct levels to trade from increases the odds of finding solid trades.
This article will explain how I use price action and the candlesticks that get printed on the charts to make marking these key hunting levels a very simple process but to begin with we need to go over what supply and demand is and how it effects movements in price.
What is supply and demand?
Let’s start by defining what supply and demand actually is.
Supply is the measure of how much of a particular commodity is available at any one time. As the supply of a currency increases, the currency becomes less valuable. Conversely, as the supply of a currency decreases, the currency becomes more valuable.
Alternatively, demand is the measure of how much of a particular commodity people want at any one time. As the demand for a currency increases, the currency becomes more valuable. Conversely, as the demand for a currency decreases, the currency becomes less valuable.
Therefore, price reversals and support and resistance levels form when we have imbalances in the supply and demand. If we look at any Forex pair on any particular time frame, price will be contained within two boundaries a support level situated below the current price and a resistance level situated above the current price.
The resistance level acts as the ceiling for price and indicates where supply is higher than demand and this is where we’d expect price to be pushed back down lower.
The support level acts as the floor for the market and indicates where demand is higher than supply and these are the levels where price bounces off and moves higher from.
Using the information on the charts to mark key levels.
Now we have a better understanding of supply and demand and how it can effect price movements I can start to explain how we can mark our key support and resistance levels. As a price action trader I rely solely on the use of candlestick charts and by using these candlesticks we are able to mark the important key levels relatively easily.
If we start by looking at the anatomy of the candlesticks that get printed on the charts, we can learn a lot about how price has reacted in the past. We can see where price has been rejected from and also where price has closed for each period of a specific time frame. Knowing where price has been rejected from and where it actually closes are both very important pieces of data and I use both to help me place my key support and resistance levels.
It’s very easy to recognise where price gets rejected from and this is done via the candlestick wicks. The wicks of candles tell us at what point price has reversed from and the tips of the wicks show exactly where price has been reversed from. We can also examine the size and length of the wick as it can indicate the strength of the rejection (larger wicks = larger rejection). So the wicks of the candles provide us with some very key data to see where price reverses from.
The second piece of information a candlestick provides that is worth considering, is where each candlestick closes. Looking at where each candlestick closes helps us to see where price struggles to close beyond and this data can help us to find price flip zones. Flip zones or flip levels are where levels switch from support to resistance and vice versa.
An example of a flip zone would be a support level which prevents price from closing below it but once price does break lower and closes below it, the level flips from a support level to being a resistance level, rejecting and preventing price returning back above the level. These flip zones are important areas to look out for and can help us determine key areas in the market.
Above is a chart to show you what a flip zone looks like. If we start on the left hand side of the chart you can see price has tried but been unable to close above the level (labelled 1). This level is currently acting as a resistance level.
When price does finally breach the resistance level and closes above it (labelled 2) we can see price retest the level 6 times (labelled 3) but price is rejected and cannot close below. This is now acting as a support level and so the level has flipped.
Finally, we get a large bearish candle (labelled 4) close below the flip zone and we then can see price retest the level twice but it is unable to close back above. This level is now acting as a resistance level.
Price pushes lower but tries again to break back above the resistance level and we can see a pin bar (labelled 5) form with its wick indicating a strong rejection of the level.
This level is clearly a strong key level and it is very easy to see how price obeys the level and so we would deem this level to be a price flip zone or flip level.
Once we can identify these flip zones which tie in as many candlestick wicks and candle closes as possible we will start to mark and find consistent key levels to trade from.
Take a look at another chart shown below which will hopefully show you how I have marked both my support and resistance levels. I try to get each level to link in with as many of the candlestick wicks as possible making sure to consider the candle closes and reading how price reacts once it breaches each level.
Looking at both the resistance and support levels marked you can see how the levels contain price and only once price finally breaks out and closes beyond the level does price manage to make a strong move away from the levels.
Key levels like these which have been tested numerous times and have rejected price, are the ones we want to follow. We really need to see a level tested atleast twices and caused strong rejections to consider the level a strong level to trade from.
So to recap, the marking and finding of the key support and resistance levels requires a combination of both the candlestick wicks and candlestick closes, both play important roles in determining our support and resistance levels.
If we can learn to determine the key levels which once broken turn and reverse their polarity we will start to be able to quickly find the important areas to look for trades to form.
By asking ourselves, the simple question “at what point if price does manage to close beyond a certain level does the chance that price will continue further away increase, rather than be contained and held by a level?” By asking this question to yourself when scanning the charts you will begin to see the key levels much more quickly and they will start to ping out from the charts.