Support and resistance levels are key indicators of the relationship between supply and demand.
In financial markets, prices depend on fluctuations in supply and demand. When supply increases, prices tend to fall, creating expectations of lower prices and more selling. When demand increases, prices tend to rise, creating expectations of higher prices and more buying. These terms have similar meanings: when demand rises, prices rise; when supply rises, prices fall. When supply and demand reach equilibrium, prices stabilize.
1. Identify the Trend
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Analyze long-term charts first. Start by examining monthly and weekly charts that cover several years. A broader “market map” provides a clearer long-term vision.
Once you have established a long-term perspective, check daily with intraday charts. A short-term market viewed in isolation can be confusing. Even if you trade in very short time frames (scalping), it is better to follow the medium- and long-term trend.
2. Align Yourself with the Market Trend
Decide on a trend and trade with it. Market trends can be long-term, medium-term, or short-term. First, choose the trend you intend to trade and use the appropriate charts.
Make sure you trade in line with that trend: buy near the bottom in an uptrend and sell near the top in a downtrend. If trading medium-term, use daily and weekly charts; if trading short-term, use daily and intraday charts. In all cases, rely on long-term charts to determine the main trend, then use shorter-term charts for timing.
3. Identify the Highest and Lowest Prices in the Trend
Find expected support and resistance levels. The best place to buy is near the market’s support level, typically based on previous cycles but slightly lower. The best place to sell is near the resistance level, usually at the peak of earlier charts.
Once a resistance level is broken, it often becomes the new support level during the next pullback—old highs become new lows. Likewise, when a support level is broken, old lows become new highs.
4. Know the Retracement Levels
Measure the percentage of a trend’s pullback (retracement). Market corrections often return to key portions of the previous trend.
Common retracement ratios are 50% of the previous trend. Smaller retracements are often about 1/3 and larger about 2/3. Fibonacci levels of 38% and 62% are also useful.
When buying, consider entering at points between 33% and 38% of the retracement zone.
5. Draw Trendlines
Trendlines are simple and effective charting tools. All you need is a straight line and two points.
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Uptrend lines connect two successive low points.
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Downtrend lines connect two successive high points.
Prices often move along these trendlines before continuing their direction. A breakout from the trendline typically signals a trend reversal.
6. Follow Moving Averages
Track the movement of moving averages (MA). They provide objective buy and sell signals, confirming whether an existing trend remains intact and signaling possible trend changes.
The most common method is observing when two moving averages cross (MA crossover). Typical combinations include:
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4-day and 9-day MA
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9-day and 18-day MA
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5-day and 20-day MA
Signals occur when shorter-term MAs cross above or below longer-term MAs. A price move beyond a 40-day MA also gives strong trading signals.
7. Recognize Reversal Signals
Oscillators help detect overbought or oversold conditions. While MAs confirm trend changes, oscillators warn when prices have moved too far and may soon reverse.
Popular oscillators include the Relative Strength Index (RSI) and Stochastics, both ranging from 0 to 100:
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RSI above 70 signals overbought, below 30 signals oversold.
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Stochastics above 80 signals overbought, below 20 signals oversold.
Traders often use a 14-day Stochastic or a 9–14 day RSI. Divergences in these indicators often warn of market reversals.
8. Watch for MACD Signals
The Moving Average Convergence Divergence (MACD), developed by Gerald Appel, combines moving averages and oscillators.
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A buy signal appears when the fast line crosses above the slow line below the zero line.
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A sell signal appears when the fast line crosses below the slow line above the zero line.
Weekly MACD signals are more reliable than daily signals. MACD histograms—vertical bars showing the difference between the two lines—give early warnings of trend changes.
9. Determine if a Trend Will Continue
Use the Average Directional Movement Index (ADX) to determine if a market is trending or ranging.
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A rising ADX indicates a strong trend.
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A falling ADX suggests a sideways market with no clear trend.
This helps traders decide the most suitable trading strategy.
10. Confirm with Volume and Money Flow
Volume and money flow confirm key signals. Trading volume typically leads price action. A strong uptrend is usually accompanied by rising volume and money flow.
If volume and money flow decrease, it signals the trend may be ending. Solid price levels in a bull market typically occur alongside increasing volume and money flow.