Here's a snip from a trading guide that does a pretty good job discussing basic concepts of support/resistance:
II.6 Understanding Support and Resistance
What technical analysis calls support and resistance is actually the result of a confluence of buying and selling at a specific price. Remember that we are trading people and psychology, not merely stocks. Thus, this confluence of buying and selling is the result of groups of people willing to buy at a specific price - thereby creating support - and groups of people who want to sell at a specific price â thereby creating resistance. This activity results in trading congestion at specific price levels.
Support and resistance is a key tool in the professional traderâs bag for identifying trade entries and potential exit points. It is also fundamental to intraday swing and breakout trading. It is therefore imperative that a trader understands the nature of support and resistance, where to look for it, and how to apply it.
II.6.1 The nature of support and resistance
Why does this occur? Remember that we noted that one of the most poorly understood aspects of technical analysis is that it often works because so many people subscribe to its tenets. We see support and resistance many times BECAUSE so many people (especially professional traders) expect to see it and act accordingly.
Knowing first to expect it, and then where to expect it, provides you with advantages over normal retail traders. Remember that the bulk of the retail-trading crowd is unsophisticated in technical analysis (although many of them think otherwise), apply the techniques improperly, or draw the wrong conclusions. The actions of professional traders and money managers often drive the stock market (both directly in the equity market and indirectly from the futures market). So knowing what they look at is an important step to helping you get an edge over other retail traders. Most retail traders are late to react. You can benefit if youâre ahead of them.
Donât expect to beat the pros at their own game. Just plan to beat the other retail traders out there. Thatâs what the pros are doing anyway. Theyâre really not trying to beat out each other as much as theyâre trying to get their share of extracting profits from the retail trader/investors.
Consider what happens when a price finally punches through a key resistance level. Often thereâs a pile on when late comer retail traders realize they should be getting in on the action. This creates breakouts. Usually, professional traders are already in before the breakout really takes hold because they knew where to look for it. They then ride the breakout for a while and sell into the buying strength in advance of the next key resistance level. They often thereby reinforce that next resistance level by their selling - again, remember that support and resistance often occur as a result of people expecting it to occur - a kind of self-fulfilling prophecy.
II.6.2 Where to look for support and resistance
As we noted above, support and resistance is the result of buying and selling activity - when similar volumes of buying and selling converge. When volume is sufficient, the resulting stalemate between buying and selling creates congestion. Such congestion may occur for a minute or two or if the volume (and therefore the congestion) is sufficient, the congestion is profound enough to create what technical analysts and chartists see as persistent support and resistance.
Note that every support/resistance (SR) level is not an opportunity to enter a trade. There are specific SRs that are key boundaries that are suggested as potential trade entries. However, multiple SRs exist during the day and are important for trade management, as we will see in the next section.
But if SRs form as a result of trading activity, how do you know where to look for SRs in advance?
Some areas of potential support and resistance are obvious - key exponential moving averages, key highs and lows, etc. Again, people act based on these and thus can create or reinforce support and resistance. For example, key exponential moving averages that are tested intraday and hold are often good entry points because enough traders and/or investors are acting based upon them.
However, modern techniques take this several steps further than simple EMAs and high/lows or old style pivot points. Analysis of the intraday price action at a granular level and use of a set of multi-temporal algorithms can project high probability zones of intraday support and resistance.
