Support and resistance trading is the core of technical analysis trading. There is an effective way to use support and resistance and I will use this article to explore a few less-known facts about this fundamental trading concept.
The right way and the wrong way to draw support and resistance lines
Before you even start taking advantage of support and resistance, you need to learn the right way to draw these “magnetic” lines.
A big mistake some traders make is that they focus on drawing support and resistance from the left side of their charts. It’s imperative to understand that the right-hand side of your charts is much more important. The current data is more important than what has happened in the past as the most recent price action better reflects the supply and demand equation.
As a general rule, you should always start on the right side and then work your way back.
Use Zones, Not Lines
The second trading tip is to use support and resistance zones instead of support and resistance lines. The price is a very dynamic concept and the volatility changes constantly and makes it very hard to make a trading decision based on individual lines. By using zones, you’ll have a much better frame of reference from which to make trading decisions.
How to Trade with SR Zones
The most common way to trade support and resistance is to buy at, or near, support and to sell at, or near, resistance. However, by the time you’ve identified the SR levels, those lines on your chart would already have multiple touches, and contrary to popular belief, the more a support/resistance level is hit, the weaker it becomes.
Important: The more a support/resistance level is hit, the weaker it becomes.
To increase the effectiveness of support and resistance, we need to implement new solid trading tactics. Without using some filters, in the long run, support and resistance trading will not generate the desired results.
I am proposing an unorthodox approach to trade support and resistance, which is based on fading retail stop losses. The support and resistance levels are not only used for entries, but they are also frequently used by retail traders as a place to hide their protective stop losses.
The big sharks often use this information and target those stop losses that reside above resistance or below the support level. Once a support or resistance level is broken, there are only two things that could happen:
- The price continues to move in the direction of the breakout or
- The price reverses and moves in the opposite direction.
Now that we know how the price behaves around support and resistance, we can use this knowledge to our advantage and develop a trading strategy. The best approach, or the one that yields a higher winning rate, is when you try to fade the support and resistance breakout.
For this trading approach to work, you need to select the “right” support or resistance level carefully. So, start from the right side of the chart with the most recent swing/pivot points and move your way to the left. If you manage to connect at least two points of references you can move to the next step.
The second step is to wait for that level to get broken. If the breakout happens around the London open or the New York open, then the pattern becomes even more reliable. The entry strategy for this breakout and reverse pattern is quite simple.
If we’re trading off of a support level, we buy once we close back above the broken support. Typically, you would like to see a strong close above the support level.
The ideal place to hide your protective stop loss is below the swing low that resulted from the breakout. This trading strategy will ensure that even if you’re stopped out, you will only lose a minimal amount of the investment compared with the potential profits available to be made.