Support and resistance are absolutely important concepts for all traders. Supporting what – and resisting what – are the questions that most new traders ask in their own minds. The easiest way to imagine ‘support’ is by reference to physical analogies.
Forget about charts and trading for a moment. Have you ever needed a loan from friend or family? If not just imagine it. A loan is a form of support. You don’t want your account to go below a certain level, else you may risk going into overdraft or being charged by your bank some sort of penalty. So, you need support of a temporary injection of cash to your account. In essence you’re trying to prop up the balance in your account. You don’t want it to fall below a certain figure.
Now back to trading. In trading terms ‘support’ means that on the charts, the collective minds of all traders don’t want the price to fall below a certain level. That level is not a fixed line. It’s a band or range of price. See annotated charts below.
There is no bank or anybody at all to decide what level they should settle on. So in the psychology of the collective, they all (in the majority) look back to important price areas on the history of the currency or stock, for security. They say to themselves (in their collective minds), at least for a while, “But 6 months ago [or whatever] we were at X level and we don’t want price to fall (or rise) beyond that price.” That average price – whatever the collective decides in their numbers – is rejected. It’s more complicated than that for sure but I’m only trying to simplify a concept so that it can be useful.
These charts may seem unbelievable. Most very new traders tend to doubt that support and resistance bands exist. An appreciation of how powerful these concepts are is usually realised through experience. We’re not here to convince anybody of anything. If you don’t believe any of this, that’s fine.
What’s the value of these concepts? They are a guide – only a guide – to deciding where perhaps entry and exit points in a trade may be made and where stop-losses or limits may be placed. A range of other parameters will need to be assessed in making a sound decision which improves the probability of beating the markets. But remember that the market is all-powerful. It can decide what it wants to do, sometimes contrary to your best analysis.