Ok, here we go. The first thing you must do when trying to identify S/R levels is to find places on charts where price was rejected. The market never moves in a straight line and as it advances, it creates highs and lows. The highs become resistance and the lows are now support, just like the picture below.
Once the resistance is broken, we have a new high forming and that will become resistance. The lows are support and the next higher low (in an uptrend – see picture above) will become the new support. We call this minor resistance and minor support. If price touches a level of support or resistance more than once, that level will become stronger and we will call it major support and major resistance. Here is an example of major support:
And major resistance:
Once you have identified a major S/R level, keep it on your chart, because even when it will break, it will still be important. Broken support levels often become resistance and broken resistance often becomes support. This is valid for minor and major levels. Here is a picture to help you understand:
There is one more very important thing you should know about S/R levels: they are not exact numbers, but more a zone that rejects price. In the picture below, we have a zoomed out chart for you to see how S/R levels are sometimes a zone. When you will watch the charts, you will encounter a lot of situations where price apparently broke the level, but was soon rejected. That is still a valid S/R level.
Trading Support and Resistance levels
Just like in the case of trend lines, you can trade the bounce or the break of a S/R level, but knowing what are the conditions for a valid break or bounce will come with time and experience. We can give you a tip though: the break of a S/R level by long candles, with small or no wicks and strong momentum, is more likely to be a real break. What we know with a high level of probability is that price will react when it meets a S/R level. Sometimes, even the lack of reaction is by itself a reaction. Let us explain this with an example: price formed a nice level of support, touching it five times and being rejected every time, but the sixth time, it went right through, with no reaction to the previously strong level of support. This is a clear indication of tremendous selling pressure and probably you won’t even see a test from below of the level, but price will continue its move down. This is when no reaction to a S/R level actually means price reacted.
Further, we will go into more detail regarding the psychology behind the support level in the case presented above: sellers are trying to push the price through the support level, but every time they reach the support, buyers push the price higher. As we know, all levels fail and eventually our support level will fail too. When that happens, more sellers join, because they can see clearly now that buyers lost the battle. Those additional sellers will bring the price even lower. And there is something that plays a very important role: usually Stop Loss orders are placed by buyers a few pips behind the support level.
Remember one of our first lessons when we said “…when we close a transaction we actually take the opposite trade to our initial one”. Well, a buyer with a Stop Loss hit turns into...you guessed it – a seller. Now the sellers greatly overwhelm the buyers and the remaining buyers have no power. All this mechanism generates the massive amount of selling pressure needed by price to break that level of support without even returning to test it from below. After all, psychology has a lot to do with trading because markets are driven by human emotions and we can’t always control those.