When you are betting on the movement of financial instruments, it is vitally important that you have a strategy planned out. This strategy needs to cover how you will select the opportunities that you might trade, how you will enter, exit and size your positions as well as where you will place your stops.
Support and resistance are useful features of price action that you can use to profit from in financial spread betting. This article firstly looks at the definitions of support and resistance and then looks at a couple of examples of how you can use them to your advantage.
Support represents a price level at which more buyers than sellers have historically been found. If you look back at a chart of recent price action, you may see that there are certain levels of price that the instrument has fallen down to only to bounce back up again. These price levels are significant in our financial spread betting because history often repeats itself. If there is a price level at which more buyers than sellers have been found before to support the price level, then there is a chance that more buyers might be found there again.
Resistance is the opposite of support and represents a price level at which more sellers than buyers have historically been found. You may see on a chart that price has historically risen to a certain level but failed to break through and retreated. Again, these levels are significant in our trading because history often repeats itself. There is a chance that if more sellers than buyers have been found at that price level before, then more sellers might be found there again.
We can create trading strategies using support and resistance by closely examining what happens at these critical levels. Price will either bounce off the support or resistance level or it will break through it. We can devise trading strategies to profit from either occurrence, but it pays to always try to trade with the underlying market trend.
Trading breakouts through resistance is a profitable strategy. If the underlying market is bullish, we want to favour longs in our trade selection. If, for example, we find a stock that is climbing with momentum as the underlying market is moving up, it is a good candidate for a long trade. If that stock has previously bounced off resistance levels and is now approaching those levels, we may want to enter a long position if price breaks through. Once in the trade, our stop loss is placed slightly below the level of prior resistance because this level now becomes our support.
If the market is bullish and our stock has been climbing but is now retracing, we can use support levels to enter another trade with a tight stop. As the stock retraces to our support level, we can enter a long position as soon as it bounces off the support level. Our stop loss is again just underneath that level of support.
Short set ups can be found when these conditions are reversed. In both these trade set ups, don’t assume that the market will do what you want. Always wait for confirmation of the set up before entering your trade. This will allow you to achieve an acceptable win/loss ratio.