2 Key Clues to Understanding Support and Resistance Levels

While my trading team and I are mostly on vacation for the month of July, I wanted to write a brief article giving 2 key clues to understanding support and resistance levels, which is also a follow up to my prior article the best support and resistance levels part 1.  If you can learn to understand these two key points, you will be able to detect key levels, when they are more likely to hold, and when they are more likely to be broken.

 

1) Prior History, Time Degradation, & Reactions to Key Levels in the Past
When analyzing to see if a level is one where traders are more likely to place trades around, we have to see how price reacted to those levels in the past.

Did price react very strongly to it in the past, say approach it one time, then reverse sharply off of it?  If so, then its very likely the next time it approaches that level, traders will place orders around there expecting a similar reaction.

 

Why?

If price produced a very violent or strong reaction to it in the past, this was because a large amount of money was put on the line stating ‘this is the line in the sand, this is highly over-valued or under-valued and we are placing a large bet here’.  When this happens, its the first institution to get in that has the highest chance for profit, because they are the first to try and reverse the pair, thus getting the best price. But they also carry the most risk.

Regardless, if their reversal attempt works, other institutions will catch wind of this, and attempt to get in as close to the rejection level as possible.  It really becomes a race between the institutions who can get the best price so many vie for it.  This helps to further fuel the rejection and create a stronger reaction.

Smart traders take note of this level producing such a strong rejection and will more than likely take a play off of it a second time expecting it to hold.  If an institution placed a large amount of money at a key level, they will likely defend it a second time (along with others as well).  So expect this level to hold.

But…the reaction the second time around is usually not as strong.

 

Why?

Because more people are aware of it the second time.  If it was a support level that produced a violent bounce, the second time around the sellers heading into that level will take profit.  This means there is less of an opposing force on the sell side, so when the market bounces, there are less sellers who have to exit and thus fuel the counter trend play.

A good example of this is below in the daily Gold chart

 

Chart 1.1 Gold Daily
2 key clues to understanding support and resistance levels 2ndskiesforex.com july 20th

Gold was in a strong uptrend for all of 2011, eventually reaching $1900 an oz after climbing 3 out of every 4 days from July into mid August.  Looking at the chart above, gold sold off quite heavily after reaching the $1900 level, selling off almost $200+ in 3 days.

Notice how the second time it approached this level, it held, but took over 13 days to sell off the same $200 amount.  The first reaction was far more violent, while the second more tempered.  The level held just fine, but when you see these situations, expect the response to be not as violent but still providing a great trade opportunity.

So anytime you see violent reactions to a level, look to place a trade at that level, expecting it to hold and produce a similar measured move.  Obviously, if the reaction happens on a higher time frame, there is a greater chance it will produce a similar reaction.  Whereas on a lower time frame, this will probably be less likely so be a little more choosy when looking to make a play like this.

Other factors to consider besides the strength of the reaction when understanding support and resistance levels is if the level produced a breakout pullback setup, has held several times in the past, and how much time the market spent at those levels.  All of these factors will determine if there is a good setup there at that level.

 

2) Current Price Action
So often when people talk about levels, they only focus on the past and seem to forget to look at how the price action is behaving in the present.  Just because a level held nicely in the past doesn’t mean it will this time and you’ve probably experienced this, expecting a level to hold only to watch it get broken.

By learning to read the price action in real time, you can see if the market is approaching it with strength or weakness, impulsive-ness or corrective-ness, and then use this information to determine if a level will hold the oncoming assault or buckle forming a breakout or trend continuation.

Levels are just areas where traders place orders, but if the defenses of those levels are weak, they will not withstand the attack, so it is crucial you are always watching price action in real time to determine if this will hold.

Although I place my orders at key levels I think will hold, if the market is approaching it with several signs of strength, then I will consider waiting for a price action trigger at this level, or for it to hold before placing my order.

Below is an example of a key level that held in the past, but completely failed the second time with the market showing strength and signs it was going to fail.

 

Chart 1.2 EURUSD Daily
key clues to understanding support and resistance levels 2ndskiesforex.com july 20th chart 2

When the EURUSD started its massive sell off in late April, it did so in impressive fashion shedding over 600pips in 13 days with only one bull candle in the entire selloff.  When it was approaching the yearly low (at B on the chart) around 1.2627 in 2012, notice how the selling started to pause going from really large impulsive candles to two small doji-like candles.  The transition or change from large candles to small suggested hesitation on the sellers part heading into a key level they suspected might hold.

This weakness and hesitation was a good real time price action clue the market was likely to produce a bounce from the yearly low, and bounce it did, forming an engulfing bar which bounced about 150pips in two days.  Many of our price action traders got in on this one, not only reading the weakness, but also using quantitative data on price action specifically for the EURUSD which communicated a likely reversal.

But notice what happens after a two day bounce – price then sells off aggressively again taking out the prior days lows and eating into over 75% of the two days’ gains.  This communicated to us in real time the sellers came back in force and were making an aggressive attempt to take out the level.  So this was a good price action clue not to place another buy order at this level.

Notice how after it broke, the level served as a key role reversal level which gives us an opportunity to get short and join the trend.

There are many other clues one can use to read the price action in real time to determine if the level will hold or break, but these are just a few hints you can look for, along with looking for price action triggers off these key levels and quantitative data to support your level as well.

 

In Summary
So these are just 2 key clues you can use to understand support and resistance levels.  It is critical to understand specifically how the market responded to a level in a past to determine first if it is a good level to make a play on.

But, so many times I hear traders talking only about how the market reacted in the past, and not paying attention to how the price action is developing in the present – which is a real time communication to the underlying order flow behind the attack on the support or resistance level.  By learning to read this, along with level 2 quotes, you can greatly increase your ability to understand and place trades around key levels, either using them for reversal plays, breakout pullback setups, or looking for potential breakouts around these key levels.

For those wanting to learn to trade price action, get access to the traders forum, quantitative data on price action, lifetime membership & more, visit my forex price action course page.

 

 

 

Buddhist, Trader and Philanthropist

I'm Chris Capre, Founder of 2ndSkiesForex. I help traders of all levels change the way they think, trade and perform. As a professional trader, I specialize in trading price action. As a teacher, my passion lies in showing you how to re-wire your brain for successful trading. Want to improve your edge right now? Visit my Price Action Course page.

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  • Rahulsinh

    Spot on….

    Hey Chris you are god of PA… thanks for this article.

    Hope to meet you some day … (if possible come to india and teach us more)

    regards
    rahulsinh

    • Hello Rahulsinh,

      Thnaks for the kind words, glad you liked the article.

      Kind regards,
      Chris

      • Rahulsinh

        so when you plan to visit india…

      • Hadn’t planned on it
        But some day for sure

  • Eklavya

    Chris,
    Very impressive details provided by you. Thanks.
    Even Sam thinks lot like you or you are think lot like same at here, only bcoz you both are Very good PA traders.

    Very nice keep it up

    • Hello Eklavya,

      Glad you liked it. I feel like I have my own style of understanding price action and perhaps some elements cross over, but those who have taken my course
      see it as unique and like nothing they have ever seen.

      Anyways, glad you liked it.

      Kind Regards,
      Chris

  • Elaine

    That’s a Awesome Article! I really appreciate your effort Chris! Just curious, i have been wondering whether did you use any market depth for your trading?
    Warmest Regards
    Elaine

    • Hello Elaine,

      Glad you liked the article.

      I do not use market depth for my trading. Although it can be useful, I find it an incomplete tool. But has some good points.
      Regardless, I just read price action and trade from that.

      Hope that helps.

      Kind Regards
      Chris

  • Itu

    If I may ask…What EMA are you using?

    • Hello Itu,

      I am using the 20ema.

      Hope this helps

      Kind Regards,
      Chris Capre

  • Itu

    Ok thanks!

    Thank you a lot for your website. Through my discovery of using PA I realized that I had to learn who was moving Price in order to know how to trade Price Action…

    Thanks a lot. Your website is really helping me discover a lot about PA. I’m doing massive research and investigation to figure this thing out.

    My goal is to learn Forex and be profitable in under a year. And you are def contributing to that. Now that I know that I need to find key levels and look for Price Action at these levels I’m starting to develop more of a strategy then guessing.

    Thanks a lot for the help!

    By the way I have a list of subscribers and I want to send them products that they can purchase and in return I can earn a commission. If you have one or know anyone that has a quality product that I can send to my list please let me know.

    Thanks!

  • Kos

    Another great one Chris. Once traders come to instantly recognize support/resistance levels, then they will take the next step and come to realize the *stops* that lie above and below (including their own).

  • ishmael

    i love your articles,they are really informative,i have a challenge of not recognizing most of the PA setups,i have been depending on the pin-bars and engulfing but lately they have been hard to find,sometimes i can go for a week or more without a trade.some trades i can detect the direction well but cannot find an entry signal and i see the pair going the direction i had predicted leaving me out.Are there any other set ups i can use?Thank you and God bless you so much

  • Max Ahartz

    Great article, Chris! What is Level 2 and how do you access it? I trade with FXCM and they have never offered it to me. I have only heard about it from trading stocks. Thanks!

    • Hello Max,

      Glad you liked the article.

      Level 2 quotes shows basic market depth. You can get it in the Active Trader platform with FXCM.

      Hope this helps.

      Kind Regards,
      Chris Capre

  • Robert

    Chris,

    Another great article. I think it is extremely important to know this article. I thought that such S/R levels were mainly swing highs/lows. I know realized it is a LOT more than that!

    In fact,I read it and studied it about 5 times! What is interesting is that there is more “psychology” in the price action. You mentioned a violent reaction to a level and a 2nd attempt to the same level that is NOT as violent as the 1st one mostly likely will NOT break through the said level.

    Question: What consitutes a violent reaction? Large candles (like exhauston and climax)? Pin bar with large wick (whether the wick went through the level or not)?

    With respect to the second chart, by the looks of the large bearish candle at B (meaning the sellers want to gain control) and while the “reaction” at A was weak, it is most likely the A-B level will be broken.

    So would it be good to say: 1st attempt at a level was a “violent reaction”, then, 2nd attempt reaction will be “timid” and reverse away from the level; on the other hand, if the 1st attempt was non-violent (no large candles including wicks), then the 2nd attempt is more likely to break through the level, assuming the price action prior to the second attempt was “impulsive”. Please correct me if there was anything wrong I said. Thank you for the great article!
    Robert