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?

supply and demandLet’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.

sr1The 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.

candleIf 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.

Candlestick wicks

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.

Candlestick close

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.

 

flip2

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.

r a s2

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.

Which time frame should we use?

The next important consideration we need to make is what time frame we should use to mark our key support and resistance levels from.

To make things as simple as possible we need to have charts which are clean and uncomplicated and to achieve this we need to have the minimum number of levels on the charts at one time. By using only one single time frame to mark the two key levels from, we will produce the clean charts we desire.

Which time frame should we use? Well to put the odds in our favour we really want to make sure we are trading from the very best levels, we need to make sure we are choosing the strongest and most powerful levels, where the percentage of traders who are watching a certain level is much higher and so where strong price reversals are more likely to occur. Comparing all the time frames available to us, I believe the daily time frame is the best option.

Why? Well, by using the daily time frame we ensure we are marking levels which have proven themselves to be extremely important and have resulted in very strong reversals forming. Because we are using levels which have in the past produced strong rejections /reversals we know the chances are lots more traders across the world will be looking in the same areas and similar reactions could occur in the future.

When we place trades we ultimately need other traders to push price along in the right direction and so the more traders we have watching a certain level increases the chances that traders will agree with our analysis, increasing the chances of price moving in the desired direction.

Alternatively, if we marked our support and resistance levels off a lower time frame like the 1hr chart, the levels we find may not even be visible on the daily charts and so for this reason we could be trading from weaker areas where the chances are less traders will be watching and so less inclined to take a trade from and get price moving strongly.

How do we mark these levels on the daily charts?

So far I have shown you how we look at the candlesticks wicks and closes to mark our support and resistance levels but we have to remember we will always have to allow for a degree of give and take, we can never see levels as pin point accurate levels but more zones or areas where price may react and reverse. It’s all about practice and getting your eye in.

Sometimes, not all the candles will tie in perfectly but it’s about getting a happy medium and having levels that link in as many candle closes and wicks as possible. There will always be a few anomalies when marking our key levels but this is just something we have to accept.

Remember to only consider marking levels which have caused strong price reversals on the daily charts, there will be some minor levels visible but these are not where we want to take trades from.

I will now take you through the exact process of marking support and resistance levels from a daily chart.

Step 1. Pull up a daily chart of any Forex pair you like. Making sure to have the chart zoomed in correctly, I find the best view to use is by zooming the chart out completely and then hitting the zoom in button twice. This gives a nice overview of what has happened previously with price and it’s easy to see the key areas or levels where price has reacted strongly. If you zoom in too much on the chart you may completely miss a really solid level.

The next thing to do is to take note of where price is currently trading and then scan the charts from right to left. The idea here is to look at what price has done in the past and to mark the nearest support level below current price and then the nearest resistance level above the current price.

step1

Step 2. Marking the support level, this is the next strongest level below current price and we are looking to see where in the past that price has reacted strongly from, turning price around. Ignore minor levels which may have only caused pauses in price movement and look for the really strong areas which have caused big price reversals.

Once we have found an area that has caused price to reverse strongly from, we have to mark our support level. I personally use a red line and look to tie in as many candle closes and wicks as possible to get the most accurate level to work from. You can clearly see how the support level I have chosen has produced strong price movements in the past. Once this level is marked I move onto the resistance level.

The charts below show the placement of the support level, with two zoomed in charts to show you more clearly how price has reacted at this level.

sp5

Step 3. Marking the resistance level, this is the next strongest level above current price and again we are looking for a level which has caused price to react strongly from, just like the support level.

Usually, your first impressions when you look at a chart are correct and so look for the levels which really stand out immediately and clearly show strong price reversals. Looking at the chart below we can see that at point A price reversed strongly twice and then price has continued to react at point B and C, so this is the closest key level to where price is currently and a good spot to look for price action trades.

sp3dsp3c

Step 4. Now we have our support and resistance levels marked, we can use these levels on the daily time frame and also on the lower time frames as areas to look for trades. We must never have more than two levels marked at one time, this is to reduce any confusion and to keep the charts as clean as possible.

Once price breaches one of the levels we must then reassess and mark the next relevant level. So if price breaks through a support level, this will now become the resistance level and the next important level below current price will be the support level.

sp4sp4b

The process of marking support and resistance levels is one which once mastered should only take a few seconds to place on any chart.

Practice, Practice, Practice is the golden rule here.

A key point to note, is that if there are no clear levels to mark from the chart, leave the chart alone and move onto another. If you cannot find any key levels easily, then the rest of the traders out there will be in the same boat. We want to only focus and trade from the clear and obvious levels in the market, always trying to trade away from these key levels and not back into them.

Get practicing!

I hope this article has given you some food for thought and will help get you on the right track to start marking your key support and resistance levels more consistently. Granted, it’s not rocket science but it does require a good eye and some practice on your part. Once you trust your levels you can begin to hunt for trades knowing that they are forming at solid levels which will increase your chances of trades moving in the desired direction.

The next step once you are able to mark your support and resistance levels properly is to learn how to use these key levels to start entering trades from, this will be discussed in the next article and I will go through how we can use these levels to hunt for trades on both the daily and intra-day time frames.

If you have any questions, please email me or leave a comment below.

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