Support and resistance levels
What are technical support and resistance levels, and how can you use them in trading.
Technically oriented traders often use support and resistance levels as points for entering and exiting positions. The purpose is to find situations with assumed favorable risk/reward, and thus good timing for taking the position. But what exactly are support and resistance levels, and how do you find and use them?
Firstly, we must clarify that it is always about assumed support and resistance. Technical analysis involves studying graphs that show the development of a price (stock, commodity etc.) over time. The goal is to be able to form an opinion about the underlying rhythm in the price development and, on the basis of this, make a qualified guess as to what the next movement will be. However, no one knows the future, and prices will be driven by new information. They can go up, down or sideways. They can be quiet for a long time, then explode in one direction. Prices can show a clear trend, then suddenly reverse. In periods the volatility will rise, and in others it will fall. As a technician, you have to be prepared for all eventualities.
What creates support- and resistance levels?
Expect no clear conclusion on this issue. In reality, there will always be several influencing factors, and both the presence and strength of these vary over time. However, the simplest example of both support and resistance is to imagine that there are large orders in the market with a price limit at these levels. Suppose, for example, that a large pension fund wants to buy a significant stake in the American microchip company AMD. The price has come down a lot this year, and the manager places an order of the type "buy up to 1/3 of the volume with an upper price of USD 58". The result can then be as we see in the chart below. We see that AMD is close to 58 for a long time, and that all dips below this level quickly reverse. For example:
We don’t know for certain whether there were one or more such orders in the market during this period, but it cannot be ruled out. If so, it could cause a technical behavior like the one we see in the chart. Likewise, there could have been large sell orders with a lower limit of 58. The effect might have been roughly the same. A contributing factor to both creating and reinforcing such levels is that more traders become aware of this behavior, and themselves take positions accordingly. That many people want to buy below a price level, but not above, will create support for the price. After all, the price is always the balance point between supply and demand.
Typically, areas where the share has consolidated for a while, levels where there have been large volumes, previous tops and bottoms, or "gaps"/jumps in the prices will be levels that get the attention of technically oriented traders.
Static and dynamic levels
The AMD example above is what one might call a static or horizontal support level. This means that it occurs at the same price, and you can draw a horizontal line that illustrates the support or resistance. But such a level can also be dynamic, which means that it changes over time, following a certain rhythm. An example of this is trend lines that can be drawn through previous peaks and troughs, or trends that follow a moving average.
The chart below shows an example of the latter in the Nvidia share in mid-November. The price chart shows 10-minute candlesticks over a few days, and the stock trended most of the time with support at the 9-period exponential moving average. This is visible as the blue curve in the chart, and we see that all small corrections either turned before violating this or reversed very quickly after breaking the 9-period moving average over the course of these days. For example:
What causes such dynamic/trend support is not easy to know. Often, there can also in this case be large orders in the market which, for example, are carried out using the volume-weighted moving average as a benchmark. Such orders could take several days to complete, and lead to a marked increase in the price of the share like the one we see here.
Use of support and resistance in trading
When a trader has identified an interesting support level, the next step is to plan positions based on this. Such levels or trend indicators simply provide a point against which to manage the risk. But how to handle a trading position around these levels is not so easy in practice. It must be remembered that such levels are often tested several times, and we have also seen this in the example images above. The very phenomenon of support or resistance implies that a level is tested and the price reverses after doing this. However, this means that if you identify a support level, take a position in advance, and set a stop when support is broken, you will often find that this stop gets knocked out. Many times you will also be able to see that the price reverses direction immediately after your stop has been struck, and that you have been taken out of the position at a very bad time.
Most traders are familiar with experiencing this. If a price has consolidated in a trading range, it can sometimes happen that the very last thing it will do before breaking out on the upside is that it swings down and knocks out everyone who had a stop-loss just below the trading range. I have seen countless such cases, and the setup actually has its own name: "Pre main-move countermove". I may describe this specific setup another time.
It is annoying to be knocked out by such a move, but you can also use this to your own advantage. You have to remember that the definition of a support level is precisely that the price tries to go through it, but immediately reverses. If you wait to take a position until this has just happened, you can get a better entry. This can be done by setting price alarms at levels you want to monitor, or by manually following the market closely as such levels are tested. If you are extra aggressive, you can even speculate that such a movement will come and place an opportunistic order a little further down in the order book. Then you will occasionally be able to get a very good entry by catching other people’s stop-losses as the level is being tested before prices reverse. On the other hand, you will also experience being the last one to buy right before a support level is really broken. If so, you have to be very quick to exit your position again.
It is as we can see no easy task to handle such levels perfectly. But that support and resistance offer interesting opportunities for trading is a sure thing. It is however important to have a plan for all possible scenarios.
Disclaimer: After many years in the brokerage industry I started my own business in 2021. I published the book "Paleo Trading: How to trade like a Hunter-Gatherer” and launched Paleo Capital that manages a hedge fund according to the principles described in the book. I emphasize that nothing written on this blog is to be regarded as personal advice or a concrete call to take positions. Everyone must be responsible for their own decisions and familiarize themselves with the products they use.
This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.
The products are not capitalprotected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.
This information is neither an investment advice nor an investment or investment strategy recommendation, but advertisement. The complete information on the trading products (securities) mentioned herein, in particular the structure and risks associated with an investment, are described in the base prospectus, together with any supplements, as well as the final terms. The base prospectus and final terms constitute the solely binding sales documents for the securities and are available under the product links. It is recommended that potential investors read these documents before making any investment decision. The documents and the key information document are published on the website of the issuer, Vontobel Financial Products GmbH, Bockenheimer Landstrasse 24, 60323 Frankfurt am Main, Germany, on prospectus.vontobel.com and are available from the issuer free of charge. The approval of the prospectus should not be understood as an endorsement of the securities. The securities are products that are not simple and may be difficult to understand. This information includes or relates to figures of past performance. Past performance is not a reliable indicator of future performance.