Understanding the Trading Psychology of Support and Resistance

support and resistance- 9WSO Download
VIP Subscription- 9WSO Download

In studying a chart for any liquid instrument, traders will observe that prices usually move in a series of peaks and valleys. The direction of these peaks and valleys provide us with a lot of valuable information about price action and direction. They also help us in determining the direction of a trend and levels of support and resistance. These valleys and peaks create opportunities for traders to enter or get out of trades. Professional traders always like to buy at support and sell at resistance, since these trades will usually have a much higher probability of success.

In understanding theses valleys and peaks, traders need to always keep in mind that an uptrend is defined by a series of consecutive higher peaks or higher highs and higher valleys or higher lows. However, a downtrend is established when prices follow a sequence of lower highs and lower lows.

The Valleys or lower pivots help in identifying for us our support points while the peaks highlight price resistance points. A price support point or level is a place where buying interest is sufficiently strong to overcome selling pressure. As a result, prices hold at this level and eventually start to rise. Consequently, they provide great buying opportunities. On the other hand resistance points are the exact opposite of support, they represent price levels where sellers dominate and are able to overcome buyers. Price increases are halted by resistance and eventually prices start to drop.

It’s important to understand that in an uptrend, resistance levels may represent pauses or resting periods in the uptrend and not necessarily reversal points. Similarly, support points in a downtrend may also be a brief intermission in the downtrend and not a reversal of price direction. It’s critical for a trader to recognize that an uptrend is not broken until prices start to create lower highs and lower lows. Similarly, a downtrend ends as soon as prices start to make higher highs or higher lows.

If a corrective drop occurs in an uptrend that causes prices to drops all the way down to the previous low, but then prices continue to move back up, it may be an early warning sign that the uptrend is weakening and may in fact be close to ending. However, technically speaking as long as the prior low was not broken the uptrend was not broken. Sometimes, the trend is not broken and prices will move sideways for a period of time before continuing to move back up again. Trends are very powerful forces in the market and smart traders should always do their best to stay on the right side of a trend.

Support & Resistance Psychology

To understand the psychology of activity at support and resistance, we need to first understand the different postures or positions that traders may have at any price point. When we arrive at a support level, we are going to find traders that are holding long positions, traders that are holding short positions and traders that are holding no positions but are looking to get in.

At the support level, strong buyers are stepping in and prices are starting to hold. Traders with a long position that entered the trend at a wrong point, and were previously in a losing position, are now pleased that their losses are starting to dwindle and that prices will start to move their way. They may in fact be looking to add to their positions. On the other hand, when traders who are short will recognize the support level, they will exit and cover their shorts generating more buying power. Traders that are still outside will fall into two groups, one group realizes that prices are rising and they decide to immediately enter and thus help propel prices higher. The other group is still waiting for prices to dip back so that they can enter at a better price.

So as you can see that there are several groups that are eagerly waiting to buy a price dip. Naturally, if and when prices decline back near support more buying takes place. The support level becomes stronger and prices get an upward lift. Consequently prices continue to push up, until they encounter resistance.

Once again, when we arrive at a resistance level, we are basically encountering supply or strong selling pressure. Recognizing this fact, many traders that are holding long positions will want to get out quickly to capture their profits and thus create an added selling pressure. Traders that did not exit quickly are now dealing with the psychology of watching profits slip away as prices continue to drop before their eyes. They are praying and wishing for prices to move back up to capture a little more profit and capture some of the gains that they just had. As soon as prices pull back up towards resistance they see this as their opportunity to get out and sell their long position. This in turn creates another wave of added selling pressure. Traders on the sidelines are watching prices and they can see that even when prices pulled back towards resistance they dropped again, this gives many traders on the outside their queue to short and get into the market. Sure enough this creates more added selling volume and continues to push prices lower. The resistance point holds and prices continue to drop until buyers decide to step in creating a level of support.

This behavior occurs continuously in the market in every time frame. Consequently, It’s helpful for traders to understand the psychology behind the opportunities that present themselves. It helps them to time their entries better and gain a greater sense of confidence in the market. Knowledge and education are always the best foundation for profitable trading.

By Dr. John Keppler

- 9WSO Download
VIP Subscription- 9WSO Download