How to Day Trade Using Price Action: Support and resistance – Ep. 5

In today’s episode we’ll take a look at something very, very basic when it comes to day trading and price action.

We are going to have a look at Support and Resistance. Today we are going to look at horizontal support and resistance. There is also diagonal support and resistance, and when I say diagonal I mean the nature of the market when it is trending. We will have support and resistance in trends as well. In the candlestick chart an uptrend would be diagonal from the bottom left corner, to the top right corner. But we will take a look at that in the next video.

Today we’ll simply start with the basics, because this is a series in the basics of price action day trading. And horizontal support and resistance is the most basic.

I believe most, perhaps almost all price action traders use support and resistance in some way. There are many ways to use support and resistance in yoru price action analysis and this is a topic that we will revisit further on in this price action day trading series, and take a look at more and more advanced uses of support and resistance.

Let’s start with the basics, and define support and resistance. This is my own definition, if you listen to somebody else they might have different definitions. Perhaps there’s even an official definition for this somewhere, but this is how we define support and resistance, and I’m pretty sure that what we have found to work in the markets is better than what someone has found to work in books of theory.

Alright so, let’s define Support. We define this as an approximate price level where the market is not able to move lower for the time being. The reason for this is because buyers will step in and start buying when the market nears and reaches this price level, and sellers will stop selling because they don’t believe that the market is going any lower. So it’s the combined force of buyers and sellers – the buyers are active and the primary force, they do most of the job. The sellers basically help by not participating, so they are passive and the secondary force. The sellers do not actively sell, so the market is not able to break down through the support level.

So when we think about support, and think about what we learned previously in this price action day trading series – what we learned about supply and demand. In this case the demand will force the price upwards from the level of support. The lack of supply is secondary. If there had been active selling, short selling, then the price would probably not stop at the support level. Or the buyers would have to be more active to overcome the active selling.

The amount of buying could stay constant as well and support would still hold, if the amount of selling would diminish. So the buyer do not have to be actively trying to push the market up. As long as there is more buying than selling the price will move up. That also means that if there is sell selling than buying the prices will move up.

So there are two different things with the same result. More buyers than sellers, then price moves up. Less sellers then buyer, then the price moves up. We get the same end result, but you will either have the buying with bigger force and selling staying at normal levels. Or you will have buying at normal levels and sellers withdraw. So the buyer and sellers can be active or passive at any time, and it is the rate between buyers and sellers that determine where the price goes.

And we define resistance the same way, but opposite of course. It is an approximate price level where the market is not able to move higher. This is because seller will become very active and start selling when the market approaches a certain price level, and buyers will become less active, and stop buying. They see all this supply coming into the market and don’t expect the market to go higher at this time. So here it is also the combined force of buyers and sellers. In this case the sellers are the are active ones. They are the primary force, they are the work horses.

The buyer do not actively participate in creating the resistance. The buyer are simply not buying, because it does not make sense buying when the sellers are hell-bent on pushing the market down.

So just like you would step off the railroad track when you see a freight train coming your way 60 miles per hour, the buyers will step aside as they see all the selling. So they are passive and a secondary force.

Of course, this is simplified. There will always be some buying and selling going on regardless if we are at support or resistance, but the idea is that the amount of buying will be much less than the supply when we are at resistance levels. And we know from a previous video, that when supply is greater than demand, the prices will fall. Same thing at support, there will of course be selling at support as well. But the buying, the demand will be much larger, the buyers will be stronger. And when demand overcomes supply, prices will rise.

So at resistance there is a lack of demand. So the buyers are passive, the role of demand is secondary. If there had been active buying then the price would more easily be able to move through resistance. In that case the seller would have to be more active to be able to push the market down.

You should realize that the support and resistance will not appear at an exact price. Many traders draw lines in their charts, because it is so easy to do in the charting platforms, and they tend to be very stubborn about their lines and want the price to reverse at the exact price, otherwise they lose confidence in their lines.

We on the other hand consider support and resistance to be approximate price levels. We don’t care if the price moves down through the support line as long as it comes back with determination. You will very often have candlesticks that have their shadows penetrate the support line and close above. Same thing with resistance lines, there will be frequent candles with their wicks penetrating the resistance lines but the candles close below the resistance. That is 100% normal market behaviour at the levels of support and resistance. This means that the market is testing these levels. The market tries to push through, but is not able to close above resistance or below support. You can have several candles pushing through and closing on the opposite side of the line, but usually this happens on very low volume and smaller and smaller candles – meaning there is no real force behind the move. Then when you get the move back below resistance or back above support, that move will usually show its determination with big strong candles and higher volume.

Volume is something very important when trading price action. We will cover volume in future episodes. In the next video in this Youtube series we will take a look at support and resistance in trends. That’s something that we call diagonal support and resistance.

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