To trade successfully, be aware of crucial support and resistance levels. Support levels are prices at which buyers are thought to come into the market in sufficient numbers to push the price up.
Resistance levels are prices at which sellers are considered to go into the market in enough numbers to push the price down.
These levels can be determined by using indicators or by eyeballing the chart. Whichever method you choose, you must use the same method for all your trades.
Many indicators can be used to identify support and resistance levels, but three of the most popular are:
- Moving Average Convergence Divergence (MACD),
- Relative Strength Index (RSI) and
- Stochastic Oscillator (STOCH).
Moving Average Convergence Divergence (MACD)
The MACD is a momentum indicator that measures the difference between two exponential moving averages.
When the MACD crosses above its signal line, it is considered a bullish sign, and when it strikes below, it is regarded as a bearish sign.
Relative Strength Index (RSI)
The RSI measures the strength of a security’s recent price movements. It’s calculated by taking the average of up closes and down closes over a set period.
When the RSI reaches overbought levels, it is thought to be a sign that the security has become overvalued and may be due for a correction.
Conversely, when the RSI reaches oversold levels, it is thought to signify that the security is becoming undervalued and may be scheduled for a rally.
Stochastic Oscillator (STOCH).
The STOCH shows when it is overbought or oversold about its past performance. It does this by measuring the closing price relative to the high-low range over a set number of periods.
Two standard methods used when using the STOCH are the %K (slow) and%D (fast). The %K sets up levels at 80 and 20, while %D sets them at 70 and 30. When prices rise above 80%K, it is considered an indication that a security is overbought, leading to a sell-off.
Conversely, when prices fall below 20%K, it indicates that a security is oversold, leading to a rally.
Eyeballing the chart
Another way of determining support and resistance levels is to eyeball the chart. It can be done by looking for previous highs and lows or trend lines.
When security reaches a previous high, it is thought to be a resistance level, and when it comes to an earlier low, it is believed to be a support level.
Trend lines are another common way of identifying support and resistance levels. A trend line is created when two or more points are connected with a straight line. When drawing trend lines, the most important thing is to make sure that they are outlined in the right direction.
A trend line should be drawn so that the longer it is, the more support or resistance it will provide. To do this, you can draw a trend line along the bottom of a series of lower highs and connect with another trend line along the top of a series of higher lows.
Moving averages are also frequently used to determine price movements when making supports and resistance levels.
A simple moving average is calculated by adding all the closing prices over an x-period (commonly 20, 50 or 100) and dividing by x. Simple moving averages show general price trends by smoothing out any volatility in prices.
Exponential moving averages give greater weight to more recent prices, which means they respond faster to market changes than simple moving averages.
200-day simple moving average
The 200-day simple moving average is thought to be a good way of determining the overall long term trend, and when it is tested, it can often lead to support or resistance levels.
To resolve these levels, you should measure where the security falls about its 200-day simple moving average; if the security falls below its 200 days moving average, it will indicate a definite downward trend which makes for a good selling opportunity.
If security rises above its 200-day simple moving average, this would mean an upward trend representing a good buying opportunity.