Identifying Support and Resistance:

This article is about how to identify support and resistance zone, and ways to determine if it will break or hold it. I have used candle stick charts in example and prefer to use it during my chart study as it provides me information in one blink of eye.

Why candle stick chart??

In above figure green candle shows that bulls are in control and red candle suggest that bears are in control.  Wick plays an important role in candle stick analysis. Some of the charting tools use white colour for bull candle and black colour for bear candle. In strong uptrend you will always locate more of white colour candle and in down trend more of black colour candle while during consolidation or equilibrium you will see both  colour candle as shown in green box in chart below

When you see mix colour candle next to each other as shown in chart above it suggests that market is indecisive and the best thing at such a time is to stay out and wait for market to show as path.

Another important factor to note while using the candle stick for analysis is “size of the candle” which matters. Large candle reflect strong crowd emotions and are generally associated with strong volumes. Large candle implies that trend is very strong. During the period of consolidation or indecision, size of candle is comparatively small as shown in chart above. Small candle is a warning that momentum is dying off and one of the three things can happen.

1.      Either market will continue to move in side ways

2.      After consolidation market may resume the journey

3.      Or market will take turn.

So whenever you see small candle and price congestion tighten, than you stop loss.

Importance of Shadow in candle stick chart:

Shadow plays a very important role in candle stick analysis. Consider the Ranbaxy chart below

After strong down trend we can see long shadow candles suggesting buying pressure at lower levels and bulls are gaining the control by pushing the price higher. Long shadow candle at support and resistance plays very important role. Here is one more example of long shadow candle at support which suggests buying pressure at support level.

Support and Resistance:

Support indicates a level where investors are lacking interest to sell and resistance indicates level with lack of buying interest. During range bound market best strategy is to sell at resistance and buy at support. One more very important characteristic of support and resistance is , “Once Support breaks, it acts as resistance during next up move and once resistance  breaks, it will provide support during down move”

 So, coming to million dollar question about how to identify support and resistance level.  Using the three techniques mentioned below I will try to explain how support and resistance can be located on chart.

1.     Cluster of price.
2.     Price reversal.
3.    Gaps.

  

Cluster of price:

Cluster of price represents the strongest area of support and resistance.  Cluster of price is generally the area where prices are in equilibrium. Neither buyers nor sellers have upper hand on each other. Prices after breaking this zone will generally have a very sharp move.  Below chart is one of the various examples.

Example 1:

There are two price clusters in below chart, one is marked in blue and the other one is in red.  

Since November 2012 script is in downward trend, but even this fall got arrested in blue price cluster and price took support in that blue price cluster formed in August 2012 (See Point 1)  for almost 2 months (See Point 2). After breaking Blue price cluster counter almost had vertical fall till it found support at price congestion formed at Point 1.  

Below is one more chart to illustrate power of Price cluster.

Role Reversal:

Role reversal is an area of prior resistance which once broken will act as support and vice-versa. Very recent example is Nifty chart as shown below.

Price got resisted at 5965-70 level for three times and there were good corrections from these levels every time.  After breakout of 5965-70 level , it is acting as a strong support when price are returning to it.

Here is one more recent example 

Also note that long leg candle at support level is suggesting buying pressure at support level. Now coming to third way of identifying support and resistance level i.e

GAPS:

Gaps plays very important role in chart analysis. They act as magnet. Gaps can be used to identify support and resistance. Lets use the same Tata motors chart to explain the concept. On the extreme left hand of the chart there is huge break away gap. Notice how start of gap resisted price 6 times.  In the same way support can be found for any share using gaps. 

Recently I have seen many false breakouts from this support and resistance values. So instead of relying on single value of support and resistance it is always good to find zone and wait till it breaks to enter the trade.  Advantage of this technique is, if in case we have false breakout, loss amount is comparatively less and probability of success is more. I like to combine Fibonacci retracement, moving average and pivots to find support and resistance zone.

Example Using Fibonacci retracement: 

From the above chart it can be seen that trend line support is at 1210 and 50% fib retracement is 1221. So 1221-1220 (.5%) band will act as support zone. Below which support trend line support is at 1160 ad 61.8% retracement is at 1152, hence 1160-52 will act as support zone.

One more example where trend line support is nearly same as 80% and fibo retracement making it very important support. 

In the same way one can combine moving averages to find support and resistance zone, once trend line resistance are marked on the chart. Examples of the same can be found on blog.

Bounce or Break:

How do we find that if price action will break of hold the support or resistance zone? Market generally will give lots of warning and hints what it is going to do. Below is simple table that guide me to determine it.

Bounce Off Support and Resistance	Break off Support and Resistance
Low Volume as you approach the level	High Volume as you approach the level
Small Candle	Large candle
Long Shadow candle	Shaven head candle & even if shadow is there it should be in other direction.

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Hope you all have a great weekend. 

Happy Trading :)