Those who philosophize about the root causes of market movements will have certainly come to the conclusion that there is an ongoing battle between bullish and bearish participants. To help you understand this concept better, let us use a metaphor:
Imagine resistance being an immense wall that protects a city. Across the wall you have guards who make sure that intruders will be kept off. As an encroaching army of buyers gets closer to the fortified city, their aim is to defeat the guards and break beyond that wall which is preventing them from pushing the market higher. If you were a defenseless inhabitant of this city, and you saw the immense wall crumbling before your eyes, would you honestly rush in to fight this influence? Believing that the buyers would suddenly ease off is a fatal illusion. That is why I keep warning my students about shorting near support and buying at resistance. It is simply not a sensible thing to do if you want to receive a rewarding outcome. Sadly, inexperienced traders often seem to be in emotional distress, and repeat such mistakes over and over.
In summary, a support and resistance is nothing more than a congestion zone in which many market participants had an agenda to fulfill. One group wanted to break behind a wall that the other group needed to protect. Both sides have very opposing interests. Unlike indicators, price points out potential barriers with great precision. These barriers continue to have an effect after its break because those traders who hung onto their position will see an opportunity to exit with the least loss. This explains why former support barriers will act as resistance once price recovers back to it.
If you are learning to read price action, you need this basic understanding to make sense of the market’s movement. So turn off all indicators for you to begin recognizing support and resistance areas.
Dear Mr. Hagemann,
Excellent metaphor. I agree with the rationale. Your analysis seem more applicable to stocks rather than to Forex or commodities. I advocate banishing all oscillators like MACD, RSI and Stochastics except to watch for divergences.
Indicators really don’t help us in our decisions. If at all, they cloud our minds with unnecessary information. I’m only active in stock markets, but my take is that support and resistance exist in all markets. They might be harder to define, though.
They’re all about fear and greed. At resistance all those older longs who didn’t get out at the high last time (regret or fear of loss) sell up so they don’t miss out again, all those shorts who won last time try selling again to enjoy making profits again (greed). When price breaks through longs express regret at missing out on profits and buy (greed, which can lead to trend continuation) however those who shorted at the resistance feel pain at their loss (fear), buy to cover and spurt price higher further. Of course if price returns to that former resistance it is now support as those who made profit before by buying buy again (greed), those who had shorted before when that level was resistance and had been losing are now at breakeven so get out . . . ad infinitum!
Thank you for your input, Bevan. Very elaborate, I couldn’t have described it better. Your blog is a great read, will follow it from now on!