Trading support and resistance breaks
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In trading, support and resistance breaks give you bullish or bearish signals. They allow you to open a position on a financial asset. Support and resistance breaks are used in most trading strategies based on technical analysis. There are rules for entering a position that winning traders follow. We will also look at how to optimize your entry points and how to avoid false signals on a break. And we will look at how to identify false support and resistance breaks. Finally, we will address risk management through placing stop losses.
Before starting to answer all these questions, it is worth giving you a short reminder about resistances and supports. Resistances/supports do not consist of single points (high/low points) but of at least 3 points of contact with the price. However, supports/resistances can be drawn from only 2 contact points, the 3rd being used to validate the level.
Supports/resistances are not just horizontal lines formed by high/low points. These lines can be ascending or descending depending on the corresponding chart pattern (channel, triangle, flag, double bottom, head and shoulders, etc.). In a bullish channel, for example, the support/resistance lines are ascending. You then have to interpret the break differently according to the associated chart pattern. I advise you to consult our training sheets on the various chart patterns (how to trade them) to learn more.
A support break gives a bearish signal and a resistance break gives a bullish signal. In theory, once the signal is given, the price moves to the next support/resistance allowing you to make a profit on your trade.
Support/resistance breaks happen all the time on the financial markets. It is easy to find bullish / bearish opportunities using breaks. These opportunities are multiplied by the fact that they can happen on all units of time.
Opening a position on a support/resistance break can be carried out in two ways:
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When is the position opened?
- When the candlestick is closed: this prevents as many false breaks as possible. Sometimes the price tests a support/resistance on a long wick and then finally closes above/below the level. This is particularly the case during periods of high volatility (economic announcements).
- On a stop order: Before the support/resistance breaks, it is possible to place a stop order (for sale in this case) but at a level lower than the support. If you place your stop just below/above the level, a simple wick will get you into position. In our example, your order would be validated at the point of the purple circle. You would then have returned too early and probably lost out on the trade given the rebound that took place afterwards.
Advantages and disadvantages of opening a position on a break:
The great advantage of this technique is that it means that you don’t miss the start of a movement. This is often the case with large trend movements. There are a lot of trading opportunities. On the other hand, your entry point is not optimized (a first wave has already taken place) and the stop loss placement is more complicated to manage.
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When is the position opened?
In this case, the position is only opened when the price starts to move in the direction of the break again. Here again you have to wait for the candlestick to close before opening a position. The simple fact that the price makes a pullback does not necessarily mean that the price will resume its initial movement. The corrective movement can indeed be prolonged much higher/lower.
If the pullback continues beyond the support/resistance, it is the return above/below the support/resistance level that gives the bullish / bearish signal and allows you to open a position.
If the pullback stops at the support/resistance level, you have to wait for the price to plunge/rebound before opening a position.
Advantages and disadvantages of opening a position on pullback
The great advantage of this technique is that it allows you to optimize your entry point (the entry level is better than on the method with breakage). Moreover, the stop is easier to place and is done above/below the last high/low that has just been formed. However, you will miss a significant number of movements. In fact, pullbacks do not always intervene or they can intervene several days later (which can call into question the signal on the pullback, the movement having already taken place).
We have seen it, the first solution to optimize your entry point is to wait for a pullback on the recently broken support/resistance but it is not the only solution:
To optimize your entry point, you can take a first position directly at the break, then another if the pullback intervenes (at a better price). Thus, your entry price is better since it is calculated on the average of your 2 trades.
Warning, if you use this technique, you must reduce the size of your positions (divide them by 2). Your risk must not be higher than a classic trade.
To refine your entry points, you can perform an analysis on the time unit lower than that of your trade. As the resistance/support level is the same on the lower time unit, it is possible for you to get the validation of a break or a reversal on a pullback more quickly. Your entry price is therefore optimized.
Warning, this technique increases the number of false signals. It is indeed possible for you to get the signal validation on the lower time unit, but it doesn’t happen on your trade’s time unit (low wick or high wick on the candlestick).
False breaks are part of trading. You can't escape them, but you can, however, reduce the number of false signals. Here is a list to help minimize false signals on support and resistance breaks:
Even by eliminating a large number of false signals, there are still false breaks. In this case, you have to know how to cut your trade, take your loss, and accept that you will have regrets (if the movement finally goes in the right direction) rather than wanting to be absolutely right by keeping your trade. This helps to limit losses on false breaks. Here are several ways to identify a false break:
In trading, you have to consider the gains but above all think about the potential losses. You must place a stop loss protection on all your trades. You may cut your trade prematurely (manually) but you should never move your stop to prevent it from being reached. With break trading, the placement of the stop is essential and can have a significant impact on your account’s performance. Effectively, with a misplaced stop, a winning trade can turn into a losing trade. Here are several aspects to help you place your stop:
Warning!!: Depending on how far your stop loss is from your entry price, you need to adjust the size of your position. The further away your stop is, the smaller your position should be.
Trading resistance and support breaks may seem simple in theory but in practice, you have to avoid a lot of traps and, especially, know how to identify false signals. There are many techniques to avoid false breaks, but despite everything, you can't escape them. You have to integrate it into your trading plan and accept that it doesn't always work.
Even if the break is straightforward, the market can turn around for many reasons. Don't get frustrated and try to hold the position. You must be able to take your loss quickly if you identify a false signal or if the market suddenly turns around. If you do not, the false breaks will have too great a negative impact on the performance of your account. However, be careful not to confuse a reversal with a simple correction.Trades need room to breathe.
Support and resistance definition
Before starting to answer all these questions, it is worth giving you a short reminder about resistances and supports. Resistances/supports do not consist of single points (high/low points) but of at least 3 points of contact with the price. However, supports/resistances can be drawn from only 2 contact points, the 3rd being used to validate the level.
Supports/resistances are not just horizontal lines formed by high/low points. These lines can be ascending or descending depending on the corresponding chart pattern (channel, triangle, flag, double bottom, head and shoulders, etc.). In a bullish channel, for example, the support/resistance lines are ascending. You then have to interpret the break differently according to the associated chart pattern. I advise you to consult our training sheets on the various chart patterns (how to trade them) to learn more.
A support break gives a bearish signal and a resistance break gives a bullish signal. In theory, once the signal is given, the price moves to the next support/resistance allowing you to make a profit on your trade.
Opening a position on a support / resistance break
Support/resistance breaks happen all the time on the financial markets. It is easy to find bullish / bearish opportunities using breaks. These opportunities are multiplied by the fact that they can happen on all units of time.
Opening a position on a support/resistance break can be carried out in two ways:
-
At the break
: In theory, a support/resistance break is validated when the price closes below/above the level. However, the break must be clean and made on a long full candlestick (or with a long body) which marks an increase in the volumes (due to triggering numerous buy/sell stops). Here is an example of a clean support break:When is the position opened?
- When the candlestick is closed: this prevents as many false breaks as possible. Sometimes the price tests a support/resistance on a long wick and then finally closes above/below the level. This is particularly the case during periods of high volatility (economic announcements).
- On a stop order: Before the support/resistance breaks, it is possible to place a stop order (for sale in this case) but at a level lower than the support. If you place your stop just below/above the level, a simple wick will get you into position. In our example, your order would be validated at the point of the purple circle. You would then have returned too early and probably lost out on the trade given the rebound that took place afterwards.
Advantages and disadvantages of opening a position on a break:
The great advantage of this technique is that it means that you don’t miss the start of a movement. This is often the case with large trend movements. There are a lot of trading opportunities. On the other hand, your entry point is not optimized (a first wave has already taken place) and the stop loss placement is more complicated to manage.
-
On the pullback
: This is a technical event respective to a return on the support/resistance line that has just been broken. The pullback often continues beyond the recently broken level. Thereafter, the price will resume its initial movement and move to the next support/resistance.When is the position opened?
In this case, the position is only opened when the price starts to move in the direction of the break again. Here again you have to wait for the candlestick to close before opening a position. The simple fact that the price makes a pullback does not necessarily mean that the price will resume its initial movement. The corrective movement can indeed be prolonged much higher/lower.
If the pullback continues beyond the support/resistance, it is the return above/below the support/resistance level that gives the bullish / bearish signal and allows you to open a position.
If the pullback stops at the support/resistance level, you have to wait for the price to plunge/rebound before opening a position.
Advantages and disadvantages of opening a position on pullback
The great advantage of this technique is that it allows you to optimize your entry point (the entry level is better than on the method with breakage). Moreover, the stop is easier to place and is done above/below the last high/low that has just been formed. However, you will miss a significant number of movements. In fact, pullbacks do not always intervene or they can intervene several days later (which can call into question the signal on the pullback, the movement having already taken place).
How to optimize your entry point on a support/resistance break
We have seen it, the first solution to optimize your entry point is to wait for a pullback on the recently broken support/resistance but it is not the only solution:
Open two positions
To optimize your entry point, you can take a first position directly at the break, then another if the pullback intervenes (at a better price). Thus, your entry price is better since it is calculated on the average of your 2 trades.
Warning, if you use this technique, you must reduce the size of your positions (divide them by 2). Your risk must not be higher than a classic trade.
Open a position on an inferior time unit
To refine your entry points, you can perform an analysis on the time unit lower than that of your trade. As the resistance/support level is the same on the lower time unit, it is possible for you to get the validation of a break or a reversal on a pullback more quickly. Your entry price is therefore optimized.
Warning, this technique increases the number of false signals. It is indeed possible for you to get the signal validation on the lower time unit, but it doesn’t happen on your trade’s time unit (low wick or high wick on the candlestick).
How to avoid false signals on support and resistance breaks
False breaks are part of trading. You can't escape them, but you can, however, reduce the number of false signals. Here is a list to help minimize false signals on support and resistance breaks:
Take the wicks into account
When drawing a support or resistance, connect the different high/low points taking into account the high/low wicks on the Japanese candlesticks. This is the best way to limit false signals.Wait for two consecutive candlesticks
Once the level is broken, you can wait for a second consecutive candlestick to close above/below the level. This is a good way to limit false signals but has a negative impact on the performance of your trade (the entry price is often at a higher/lower price than on a classic trade).Do not take into account signals in periods of high volatility
Periods of high volatility will multiply false signals. You will often notice a lot of wicks forming on candlesticks (which can trigger your buy/sell stop) during significant economic announcements. Also, even if the signal is validated (the candlestick closes), volatility can hit your stop loss even if your scenario is eventually achieved.Monitor volumes
Because a lot of stops are triggered, a resistance or support break must normally happen with large volumes. If you find that there is no increase in volume, the probability of a false signal is higher.Watch for discrepancies
If you notice that discrepancies are forming with the indicators, despite the break in the support/resistance, the risk of market correction is significant. The larger the unit of time, the more the variation is a strong signal of reversal.Opening positions on clean breaks
The farther the break candlestick closes from the support/resistance level, the stronger the signal. On the other hand, your entry price will not be good and placing the stop will be complicated. It is better to wait for a pullback in these cases unless you notice that the bullish/bearish potential is very high.How to identify false support and resistance breaks
Even by eliminating a large number of false signals, there are still false breaks. In this case, you have to know how to cut your trade, take your loss, and accept that you will have regrets (if the movement finally goes in the right direction) rather than wanting to be absolutely right by keeping your trade. This helps to limit losses on false breaks. Here are several ways to identify a false break:
Watch the next candlestick close
Once the break has been validated, watch the next candlestick close. If it is above/below the recently broken level, the signal is invalid and you must cut your loss position.Look at the colour of the next candlestick
A break in the level of a support/resistance should normally cause a bearish/bullish wave. Several bearish/bullish candlesticks must therefore follow one another (even if the movement does not continue for a long time because of a pullback or trend reversal). If the candlestick following the break is the opposite colour to the break candlestick (bearish or bullish), it is often a sign of investor hesitation and a false signal.Long wick at the break
A break candlestick can have a long body and also a long high/low wick. This reflects the difficulty for buyers/sellers to take control. This is often a sign that the battle will be tough and that a false signal can happen. The following candlesticks should then be looked at carefully to see if the movement continues or not. In the case of a quick return above/below the break level (enclosed candlestick), it is better to cut your position.Breaks on small candlesticks
Some levels are broken but on candlesticks with a short body (which usually translates to low volumes). This is very often a sign of a false break. In this case, even waiting for two enclosed candlesticks may not be enough to avoid the false bullish/ bearish signal trap.Placing a stop on supports/resistance breaks
In trading, you have to consider the gains but above all think about the potential losses. You must place a stop loss protection on all your trades. You may cut your trade prematurely (manually) but you should never move your stop to prevent it from being reached. With break trading, the placement of the stop is essential and can have a significant impact on your account’s performance. Effectively, with a misplaced stop, a winning trade can turn into a losing trade. Here are several aspects to help you place your stop:
Place your stop according to a market level
A stop must never be determined by your entrance price. As a reminder, a stop corresponds to the level at which you estimate that your scenario will not be achieved. To start with I advise you to place it above the last highest/lowest or above the resistance/support level but with a good margin. If you see that the movement continues, you can then move it gradually as the new highest/lowest is being created. If the movement does not continue (false break, market reversal), you can manually cut your position before your stop is reached. On the other hand, if you see that the price seems to move towards a pullback after a bearish/bullish movement which follows the support/resistance break, leave your stop and do not cut your trade (even if the pullback continues beyond the level)Warning!!: Depending on how far your stop loss is from your entry price, you need to adjust the size of your position. The further away your stop is, the smaller your position should be.
Let your trade breathe
Before placing a stop, do not rush. It is usually better to waituntil you have confirmation that the movement has started again in your direction and that the correction is complete. Otherwise, you risk seeing your stop loss reached too often, which will limit your gains and transform normally winning trades into losing trades.Reduce your trading risk incrementally
If a strong movement has occurred in your direction, a correction should not normally follow the entire movement. You can then move your stop to your entry price level to totally eliminate your risk on the trade, or even move it to ensure you a minimum gain even in the event of market reversal.Conclusion
Trading resistance and support breaks may seem simple in theory but in practice, you have to avoid a lot of traps and, especially, know how to identify false signals. There are many techniques to avoid false breaks, but despite everything, you can't escape them. You have to integrate it into your trading plan and accept that it doesn't always work.
Even if the break is straightforward, the market can turn around for many reasons. Don't get frustrated and try to hold the position. You must be able to take your loss quickly if you identify a false signal or if the market suddenly turns around. If you do not, the false breaks will have too great a negative impact on the performance of your account. However, be careful not to confuse a reversal with a simple correction.Trades need room to breathe.
