Look at the diagram above. As you can see, this zigzag pattern is making its way up (uptrend). When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance.
As the market continues up again, the lowest point reached before it started back is now support. In this way, resistance and support are continually formed as the market oscillates over time. The reverse is true for the downtrend.
Plotting Support and
Resistance
One thing to remember is that support and resistance levels are not exact numbers.
Often times you will see a support or resistance level that appears broken, but soon after find out that the market was just testing it. With candlestick charts, these "tests" of support and resistance are usually represented by the candlestick shadows.
So how do we truly know if support and resistance was broken?
There is no definite answer to this question. Some argue that a support or resistance level is broken if the market can actually close past that level. However, you will find that this is not always the case.
Let's take our same example from above and see what happened when the price actually closed past the support level.
In this case, the price had closed below the support level but ended up rising back up above it.
If you had believed that this was a real breakout and sold this pair, you would've been wrong.
Looking at the chart now, you can visually see and come to the conclusion that the support was not actually broken; it is still very much intact and now even stronger.
To help you filter out these false breakouts, you should think of support and resistance more of as "zones" rather than concrete numbers.
One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart. The reason is that line charts only show you the closing price while candlesticks add the extreme highs and lows to the picture.
These highs and lows can be misleading because often times they are just the "knee-jerk" reactions of the market.
When plotting support and resistance, you don't want the reflexes of the market. You only want to plot its intentional movement
Looking at the line chart, you want to plot your support and resistance lines around areas where you can see the price forming several peaks or valleys.
Other interesting tidbits about support and resistance
When the price passes through resistance, that resistance could potentially become support.
The more often price tests a level of resistance or support without breaking it, the stronger the area of resistance or support is.
When a support or resistance level breaks, the strength of the follow-through move depends on how strongly the broken support or resistance had been holding.
With a little practice, you'll be able to spot potential support and resistance areas easily. Now let’s look at how to draw trendlines.
Trend lines
Trend lines are probably the most common form of technical analysis. They are probably one of the most underutilized ones as well.
If drawn correctly, they can be as accurate as any other method. Unfortunately, most traders don't draw them correctly or try to make the line fit the market instead of the other way around.
In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys). In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).
How do you draw trend lines
To draw trend lines properly, all you have to do is locate two major tops or bottoms and connect them.
Here are trend lines in action! Look at those waves!
Types of Trends
There are three types
of trends:
Uptrend (higher lows)
Downtrend (lower highs)
Sideways trends (ranging)
Here are some
important things to remember about trend lines:
It takes at least two tops or bottoms to draw a valid trend line but it takes THREE to confirm a trend line.
The STEEPER the trend line you draw, the less reliable it is going to be and the more likely it will break.
Like horizontal support and resistance levels, trend lines become stronger the more times they are tested.
And most importantly, DO NOT EVER draw trend lines by forcing them to fit the market. If they do not fit right, then that trend line isn't a valid one!
Channels
If we take this trend line theory one step further and draw a parallel line at the same angle of the uptrend or downtrend, we will have created a channel.
Channels are just another tool in technical analysis which can be used to determine good places to buy or sell. Both the tops and bottoms of channels represent potential areas of support or resistance.
To create an up (ascending) channel, simply draw a parallel line at the same angle as an uptrend line and then move that line to position where it touches the most recent peak. This should be done at the same time you create the trend line.
To create a down (descending) channel, simply draw a parallel line at the same angle as the downtrend line and then move that line to a position where it touches the most recent valley. This should be done at the same time you create the trend line.
When prices hit the bottom trend line, this may be used as a buying area. When prices hit the upper trend line, this may be used as a selling area.
Types of channels
There are three types of channels:
Ascending channel (higher highs and higher lows)
Descending channel (lower highers and lower lows)
Horizontal channel (ranging)
Important things to
remember about trend lines:
When constructing a channel, both trend lines must be parallel to each other.
Generally, the bottom of the channel is considered a buy zone while the top of the channel is considered a sell zone.
Like in drawing trend lines, don’t force the price to the channels that you draw! A channel boundary that is sloping at one angle while the corresponding channel boundary is sloping at another is not correct and could lead to bad trades.
Trading the Lines
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