In the Technical Analysis realm, support and resistance, commonly abbreviated to S&R, are the two most widely known and discussed concepts by traders. Chart analysts utilize these terms to refer to levels which price will likely fail to breach through, ‘preventing’ fluctuations for any asset in a specific direction. Specifically, a price level from which price has bounced multiple times and failed to break below is known as a support level, also known as a ‘floor’. On the contrary, a price area at which price has struggled to break above, or a ‘ceiling’, is referred to as a resistance level. Technical analysts employ support and resistance as an integral part of their technical analysis, with the goal of identifying price levels where there is a high probability for a reversal of trend or at least a retracement. The figures below present a few simple illustrations of S&R.
Countless traders will argue that these levels prevent the price of a financial instrument from moving in a specific direction, but how much truth is there in the effectiveness of support and resistance ? It is important to keep in mind that most technical analysis books, videos and articles teach new traders the concept of S&R. The validity of these levels relies on the amount of times they have deflected the price in the opposite direction in the past.
With that in mind, we aim to inspect how that applies in reality. Large financial institutions are very much aware of the technical methodology of retail traders, and they use it to their advantage, identifying areas in price where a high concentration of retail orders rests. Banks and other significant market participants then push prices through such levels, liquidating an enormous amount of retail orders. Often, the price reverses shortly after breaching and disrespecting support and resistance levels. Why does this occur? The answer is liquidity. Follow the next MarketNerd lesson for further insight into this topic.