Support and Resistance Trading

What is Support and Resistance Levels in Stock Trading?

Support and resistance are specific price areas or price levels which either support prices on declines in up trends or which resist prices on rallies in down trends.

 In an up trend, short term and day traders will attempt to buy at support or at levels of support. In a down trend, short term and day traders will attempt to sell at resistance levels or in resistance areas.

If support and resistance levels cannot be determined, then you cannot define concise levels in which to establish entry or exit positions in your specific trade.

It is of utmost importance for traders to develop effective strategies and methodologies for calculating support and resistance levels. These levels can be determined with the use of various trading tools like Point and Figure charts, Fibonacci numbers and Gann angles. 

Day traders is in a definite advantage when it comes to the use of support and resistance levels, in as much that the day trader’s trade normally end when the trading day is over and if a bad trade or decision was made based on support or resistance levels it will not be repeated in the next trading day.

Determining support and resistance levels are somewhat different for the day trader than the position trader. This is because support and resistance levels for the day trader must be closer to the current market price that they are for the long term or position trader.

Markets can only drop so far in one day, and consequently the determination of support and resistance levels by the day trader must be realistic in terms of what can be expected – however this does mean that day traders must be willing to use realistic technical support and resistance levels in order to establish their positions.

The following method may appear very simple, yet it is enormously effective at isolating support and resistance levels and can be applied profitably in any market:

1. Follow a 3-day moving average of the highs, and a 3-day simple moving average of the lows.
2. Take the 3-day moving average of the highs to act as your resistance level, and the 3-day moving average of the lows to act as your support level.
3. Add a filter by drawing in the support of the lows if the trade has made a 3-day high in say, the last 3 days (you can use four or five days, depending on your trading methodology) This means that you will only draw in the 3-day moving average of the highs if the stock has made a 3-day low in the last three days – this means that you only want to sell when the short term is down.

In summary you can apply this trading rule of thumb in a paper trading exercise;

• Find and draw all your levels of support and resistance.
• Draw all your trendlines - This will help you to create a "bias" and also determine if the stock you are following are in a up or downtrend.
• Decide if the trend is bullish or bearish.
• If you decide the trend is bullish, place your stop loss at the last low. Look at your anticipated risk and potential financial loss - If you decide that you cannot afford the loss, stay out of the trade.
• If you decide the trend is bearish, place your stop loss at the last high. Look at your anticipated risk and potential financial loss - If you cannot afford the loss, stay out of the trade.
• Remember to trade according to your trading plan.

This is a very simple method of trading stocks/commodities with support and resistance on a daily basis, and if calculated correctly they will work.