We will see what support and resistance (S&R) lines are, in periods of consolidation.
S&R are an essential concept in trading. In this lesson we will focus on the horizontal ones and how to trade them: you’ll understand how to develop a raw and basic trading strategy.
The notion of consolidation will allow you to have a clearer mental view of the market.
When the price turns again and again within a relatively small amplitude of movement, the markets is in a state where no explicit trend is developing, this is what we call a consolidation.
Some kinds of consolidation fit within horizontal S&R, while others require diagonal S&R. As I already said, we will focus only on horizontal lines, for now.
The exact start and end of consolidations are subject to debates.
Periods of consolidation are followed by legs up or legs down.
A "leg up": a sharp bullish movement
A "leg down": a sharp bearish movement
A resistance is an area where the price has difficulties breaking up.
A support is an area the where price has difficulties breaking down.
You can draw lines to delimit those areas, which have higher odds to see a reversal happening.
However, seeing supports and resistances as “lines” may not be the best approach there is in trading.
As you know, candles are made by humans; thus, don't expect them to mathematically bounce on the exact border of your lines. Seeing them as zones or area is more realistic.
A support or a resistance always develop on a previous point of reversal: the market is more likely to reverse at a price where it already did so.
Basically, it looks like that:
The process is simple: select the “horizontal line” tool, and put it on a level where at least two candles touch it. The more candles touch the line, the best it is.
Those lines are not everlasting. When the price gets out of a consolidation, it is called a breakout. It usually happens (but not mandatorily) with a big candle and a notable increase of volume.
Here you have an example of a bearish breakout:
Successfully identifying the early stage of a breakout could give you a good point of entry in the market!
A particularity of these levels is, that once breached, a support area can act as a resistance, and vice versa:
Here you can see a resistance becoming a support.
About volume: note how the two massive and sudden bars are short-lived price actions.
There is different ways to trade S&R levels.
It is to be noted that, trading narrow consolidation ranges, are a thing almost exclusively reserved for scalpers and day traders: their profits will be small, and in case of a breakout their losses can be great, if they don’t close their position rapidly.
More patient traders won’t try to get a +2% gain if it makes them risk to miss the incoming +20% leg up. They usually go along the long-term trend and don’t care about small pauses.
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Those simple strategies are based on two principles: