Understanding Price's Invisible Boundaries
In technical analysis, support and resistance levels are like invisible lines in the sand where prices tend to pause or turn around. They're specific price points where buyers or sellers have historically stepped in with enough force to halt the current price movement and potentially reverse its direction.
Think of Support Levels as a strong floor for the price. When the price falls to this level, there's usually enough buying interest to stop it from going lower.
Conversely, Resistance Levels act like a tough ceiling. When the price climbs to this level, there's typically enough selling pressure to prevent it from rising further.
Using These Levels to Make Smarter Trades
Let’s use the four hours chart for the S&P 500 $S&P 500(.SPX)$ , the highlighted numbers are the levels provided last Friday, ahead of the week that just finished. The candlesticks alerted the potential reversal with indecisive moves on Monday and Tuesday, until the central level (blue line) was finally breached on Wednesday morning, when the bearish reversal anticipated by technical indicators in the previous weekly compass (click here) was confirmed. In this case the level worked to confirm the new trend.
On Wednesday and Thursday, the $5,843 level acted as support, but it was finally breached on Friday, flipping to resistance level and rejecting the bounce at the end of the week.
The low of the week was not exactly related with the S/R levels, but with the 40 weekly average, a key line analyzed in the Weekly Compass.
These "floors" and "ceilings" are vital tools for traders and investors to confirm whether a trade idea is solid or if a trend is likely to continue. Here is how we use them:
Spotting Reversals:
When Prices Bounce Up (Bullish Reversal): If a price drops to a known support level and starts showing signs that buyers are taking over (like bullish candlestick patterns or certain signals from momentum indicators), it validates a potential "buy" trade (like Monday morning when price bounced from the central level).
When Prices Turn Down (Bearish Reversal): Similarly, if a price hits a strong resistance level and starts showing signs that sellers are in control (like bearish candlestick patterns or negative signals from momentum indicators), it validates a potential "sell" trade.
Confirming Trends:
Breaking the Ceiling (Uptrend Continuation): When a price decisively breaks above a resistance level with strong trading volume and conviction (solid, large candles), it's a powerful signal that the uptrend is likely to continue (that was the case in mid-April when the market anticipated its bullish reversal).
Breaking the Floor (Downtrend Continuation): If the price crashes below a support level with strong volume, it means sellers have won, and the downtrend is likely to persist. A retest of this broken support (now acting as new resistance) can confirm the continued decline (Perfect example in the chart above when $5,901 and $5,843 were breached.
Setting Price Targets: These levels aren't just for entry; they're also great for exits. If a price breaks above a resistance, the next significant resistance level higher up can become your potential profit target. The same logic applies to bearish targets below broken support. In the weekly compass, the annual levels are charted, and those levels are used as mid and long term targets based on weekly timeframe and fundamental analysis shared with premium subscribers (that was the case for TSLA and $353 set as bullish target weeks ago; that level acted as resistance this week).
Managing Your Risk: Support and resistance levels are perfect references for placing "stop-loss" orders – For "buy" trades near support, you'd place your stop-loss below that support (see the chart above, the candles slightly breach the levels, so a lower price is best to avoid stops triggered). For "sell" trades near resistance, it goes just above that resistance. This helps limit your losses if the market doesn't behave as expected.
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