Support and resistance trading is one of the most basic forms of technical analysis, yet it can also be one of the most effective when done correctly. While many traders focus on simply buying into support and selling into resistance, known as fading the range, there is another way to trade support and resistance which can often yield better results.
One of the most interesting aspects of support and resistance is the fact that these levels have a changing nature. So, broken support will often become resistance when retested from below and broken resistance will often become support when retested from above. Traders can capitalise on this common dynamic by looking to “trade the retest”.
Trading the Retest
So, in this example you can see that we have a really clearly defined support level in the market. We have two big touches giving us our support level, we then get a further test of support where once again demand kicks in and holds price up. However, you can see that support is heavily diminished at this level as the rebound off support is only very shallow and price then rolls over and breaks down below support.
So, at the point at which price has broken down through this support level we now know that demand has been overwhelmed and supply is now stronger in the market at this level. So, as price then trades back up to retest this broken support level we can then anticipate that the level will act as resistance and we can use it as an entry point for a sell trade.
This type of entry is especially great during trending markets where price action tends to display this sort of staircase structure where in bearish trends we form support, break support retest and continue lower and in bullish trends we trade up, form resistance, break resistance, retest it and then continue higher.
When trading in this manner, we can either look to just trade the level or we can take a more conservative approach where we wait for price action confirmation.
Waiting for Price Action Confirmation
So, looking at this example you can see that price is moving higher, we then form this clear resistance level at this point, identified by two touches at the level. Then we can see that demand overtakes supply and price breaks out higher. So, once price has broken above that resistance level we can then wait for price to come back down and retest it, anticipating that the level will now act as support allowing us to place a trade, positioning for a resumption of the bullish move.
However, instead of just trading the level and hoping for price to find support what we can actually do is wait to see how price reacts as it tested the level, looking to identify reversal candles that give us a clue that the level is going to hold. And, if you look at the price action that the market displayed as the level was retested you can see something interesting.
So, we traded back down to test the level, and we actually pierced a little below the level which is common, we then stalled and got this small bullish candle and then you can see on the next candle we got this big bullish engulfing candle once again which gives us a strong sign that demand has stepped in and a reversal higher is underway, allowing us to place our buy trade. So, this is the type of process that we always want to follow when using these levels to place trades.
Using the RSI Indicator
So, if we turn the RSI indicator back on for this example you can see that we get another fantastic confluent signal. At the point that price trades back down and retests that broken resistance level, now turned support, the RSI indicator was heavily oversold telling us that momentum is overstretched to the downside and a reversal higher is likely. So once again we have confluence between all three elements, support/resistance, the indicator and price action itself.
We first of all identify the level by highlighting importance highs/lows that line up and then we wait to see how price reacts once we test the level, waiting to identify reversal candlesticks. Finally if we are using any indicators such as the RSI or any others, we want to make sure that they give us a confluent reading.
Hopefully this has now got you thinking about support and resistance in a more strategic manner and opened up some different ideas for you to consider when looking to place trades based on support an resistance.