First and foremost, I am a supply and demand trader and this forms the basis for all of my trading decisions. Whilst the above is true I feel that it is important for me to consider support and resistance (also called SR for short) as part of my analysis when considering potential trading opportunities.
Essentially support and resistance represents the idea that the price of an instrument will stop and bounce from certain levels and conventional technical analysis teaches that these are areas which present good buying and selling opportunities.
Support is a level on a price chart that price is expected to rise from when it is reached. When price is moving down, a bounce or reversal is usually anticipated at these levels which would then send price up. A support level is only valid until price is able to break through it with force.
Resistance is the opposite of support. It describes a level on a price chart that price is expected to fall from when it is reached. When price is moving up, a bounce or reversal is usually anticipated from such a level which would then send price down. A resistance level is only valid until price is able to break through it with force.
When levels reverse – the SR Flip
As is commonly known in trading, sometimes the SR levels themselves reverse. What was once support can become resistance and what was once resistance can become support. Conventional technical analysis traders also look out for these areas for buying and selling opportunities. The reversal of SR levels is the type that I am interested in for reasons which I will go into later but first I will explain these SR level reversals a little more.
Support turns to Resistance
Identifying the reversal of SR levels is simple. Let’s take the scenario where a support level becomes resistance for example. You see a support level as described earlier in this article above. When price comes back the level instead of bouncing or reversing from it, price plummets straight through it. The support level is ignored. Price is clearly no longer supported at this level.
When price returns to this level we would now expect price to have a reaction but this time it would be the opposite reaction. We would now expect price to drop from this level. A picture of this type of price action can be seen below:
The support level holds for a number of days before price drops through it. On return the previous support becomes resistance and continues in the direction of the initial break to the south.
Resistance turns to Support
A resistance level is identified on the chart. When price comes back to the level, instead of respecting it with a reversal, price rallies straight through it. Price is therefore no longer experiencing resistance at this level. When price returns to this level we would now expect price to rise, continuing in the direction of the initial break. A picture of this type of price action can be seen in the image below:
Here we see a resistance level holding for 3 days before price is able to break through. After the break price revisits the previous resistance level before shooting off in the direction of the break confirming that the resistance had now turned to support.
What does that have to do with supply and demand?
If after reading so far you find yourself asking the question above, I am about to explain the significance right now.
When choosing supply and demand levels to trade from there are a number of important factors to consider. The ones I will focus on now are the arrival and the profit potential.
How price arrives at our SD level is important as it will often determine how price will leave it. A quick rally into supply will generally mean a prompt decline in price from the level. A slow creeping rally into supply can result in something totally different. Price could fall from the supply level but it could be a sign the price is about to move higher and break through the supply.
Ideally we don’t want any obstacles getting in the way of our trade and affecting our profit. This is where SR analysis comes in. Occasionally you will have an SR Flip standing in the way of a nice smooth run to profit. You can handle this in a number of different ways.
- Take the trade and hope there is no reaction at the SR level. You are trading SD not SR so ignore it
- Wait for the SR level to be tested and analyse the situation after
- Ignore the trade
How each person deals with this situation is up to them but I’m going to show you how I use the second option to benefit from moves which on the face of it may not seem too clear.
In the images above we can see an example of how waiting for the test of an SR level could have kept one out of a losing trade. This is trade that I took. What we see in the example is a sharp movement up in price to a predefined supply level. Not too far below however, a good way before the target is an SR Flip level.
Price was heavily rejected from the first level marked “SR Flip R2S” and plummeted over 100 pips from it, breaking the previous couple days’ lows as it went. When price rallied up however, it was ignored. As we know, ignored resistance can turn into support so I wanted to wait until price had tested that level before I entered a trade as I was expecting a bounce north from there.
True to form price did bounce and it went higher into the supply. 5m PA could have got me into the trade sooner but for the SR level which I thought might cause me some trouble below.
After the SR bounces, price began to signal that it was now ready to move lower without any obstacles standing in the way of the target. I entered the trade and it went as planned. Touch traders would have been in with a limit order right at the lower line and the PA would never have come close to their stop. Confirmation traders however may have taken an earlier entry with the PA that was shown and they are likely to have been stopped out before price reached the target.
This type of scenario where SR stands before profit happens all the time in the markets and one can easily enter too early and take unnecessary losses. This is why I feel that understanding and analysing SR is important. I do not trade from SR levels in the conventional way, but I do make sure that they are not standing in the way of my profit when I trade from SD levels.
I hope you found this useful.