Support and resistance is one of the most basic concepts of technical analysis for binary options or any kind of trading. This concept is the basis for many tools, many strategies and is bandied around by traders like it’s the latest greatest buzzword every created. Needless to say, I was dismayed when perusing the BOTs main website I failed to find one single article giving a simple explanation of the subject and how it is used by traders. Because these concepts are important to the basics of binary option charting I thought I would fill the void and this is what I have come up with.
The Basics of Support and Resistance For Binary Options
The most common definition of support&resistance is that they are areas where price movement is likely to be stopped. Support will stop a downtrend, resistance will stop an uptrend, but none of that really explains why price movement will stop. To understand that we have to consider the market, the its participants and the valuation of assets.
When an asset’s price retreats to levels that the market deem are low (undervalued) they buy and their buying provides support for prices. Any time prices reaches those levels buyers step in and their buying prevents prices from declining further, it is said to support them. The same thing is true for resistance. Market participants determine when an asset is overvalued and use that price as a trigger to sell. The more people who agree that an asset is overvalued and sell, the stronger that resistance will be. The easiest way to see this is on a chart, the peaks are areas of resistance the troughs are areas of support.
Not all support or resistance levels are the same and this is because there are long term traders, medium term traders and short term traders, all making decisions on different types of information. Typically, the longer the outlook the more significant the potential for support or resistance. For example, a long term 200 day moving average is often used by institutional investors and provides stronger support than a 30 day moving average which is used by short term traders. Long term traders focus on fundamentals like cash flow and profits, short term traders focus on news and emotion, trading on swings in the market. There is more long term money in the market than there is short term, the more money you can expect to provide support at a certain level the stronger that support will be.
Drawing Support And Resistance Lines
Drawing support and resistance lines is very subjective. There are quite a few different methodologies and frankly, they are all pretty good. What makes one line stronger than another is confirmation, but I’ll go over that later. The simplest way to pick a potential line is to look for peaks and troughs in the market, it doesn’t matter if the market is ranging or trending there will be areas of support and resistance. The first possibility will be the highest high, or the lowest low including the tips of upper or lower shadows. For more on candles and how to read them go to this article, Japanese Candlesticks – Trading Naked.
In the above example the lowest close of a down trend is a first target for support, if broken the tip of the lowest shadow becomes the next target. This is because these are important price levels for buyers. The first target is where buyers overpowered sellers and pushed prices higher, the second is the trigger price that got the bulls buying in the first place. The same is true for resistance levels, the thing to remember is that the strength of the level is directly related to the number of traders who think it is good for buying or selling. The more times a level is reached and provides support and resistance the stronger it gets. In the above example the 2nd target is hit, then tested and confirmed making it a little bit stronger than it was the first time. If the bounce continues the high set on Feb 1 is the first target for resistance.
Check out this article How to Guide for Drawing Support and Resistance Using an Indicator
– for more about drawing SR Lines.
Gauging The Strength Of Support And Resistance
Support and resistance have a big impact on trend and trend following strategies. In fact, trend is actually a measurement of the progression of support or resistance levels, a sideways trend merely the test and retest of the same support level. Say for example an asset touches down to the 200 bar long term moving average, a commonly used measure of long term support. The moving average provides support and prices rise above the 100 bar moving average, the rise in prices attracts traders who use the 100 bar moving average and they buy when prices touch back to their target level, then their buying pushes prices above the 30 day moving average and attracts another group of traders and further strengthens the trend. Each level is a support level and the highers levels are in term supported by lower levels. The example below shows how this concept works in a bear market.
- Two strategies that make good use of the moving average for support and resistance are the Guppy Strategy and the Geek’s Simple Moving Average Strategy.
This same concept, convergence of support or resistance levels, can be applied to multiple indicators as well as to multiple time frames. If you are finding signs of support using one indicator, and another indicator confirms it, that support is likely to be stronger than if only one indicator showed support because there are two different groups of traders in the market at that level. One example might be is Bollinger Bands ™ showed a bottom at the same place as Fibonacci Retracement, or if a pin-bar signal appears where a short term moving average crosses below a longer term one.
In the example below you can see where the Bollinger Bands ™ provide support and resistance. They do this in the near term, for short moves, but when the signal confirms with other signals the subsequent price move is more pronounced. A tool that I really like is the Stochastic Oscillator, it can predict and confirm support and resistance levels as well as give a multitude of profitable entry signals. Read this for more details on how to use Convergence of Indicators in your analysis.
Wrapping It Up
Hopefully I haven’t confused you to much. If there are any questions don’t hesitate to ask me in the forum, or one of our other pro traders. The bottom line is that support and resistance is a crucial concept for all traders to know. Choosing the best ones takes practice, and the confirmation of other indicators adds to their strength. My advice is to keep practicing drawing lines, look at how lines from past peaks and troughs affects future price action. Look at how other indicators interact with the lines that create the strongest signals and eventually you will be able to see major turning points in the market without even trying.