Being able to identify support and resistance levels within trends is one thing, but knowing how to turn these cues into profitable trades is quite another.
Trading on the bounce
One popular tactic is to trade right after the bounce. While you might be tempted to place your orders on the support and resistance levels in order to get the best possible price, this tends to be an ineffective strategy, as it assumes that the support or resistance level will hold.
If you wait until the price starts moving the other way, you won’t necessarily get the best possible price, but you will substantially reduce the likelihood that you will get caught out by a fast price breakout.
Trading on the break
In an ideal world, support and resistance lines would hold permanently, enabling the trader to make reliable predictions 100% of the time. However, in reality, these lines are broken on a frequent basis, so it can pay to know what to do when support or resistance levels give way.
There are two basic strategies for dealing with breakouts. The simplest way is to buy or sell whenever the price moves through a support or resistance zone by a significant amount. The more convincing the breakout, the more likely it is that you will profit by making this type of trade.
The other main strategy for dealing with breakouts is to keep your trade open until the price reverses. For example, if you decided to buy GBP/USD in the hope that it would continue to rise after bouncing from a support level, but it went the other way and broke through the support, then you could either cut your losses or hang on in the hope that the price rises again.
In order to break even on the trade, you have to be able to sell GBP/USD for the same price that you bought it for. If enough traders take the option to cut their losses on the break, then the price will continue to fall, creating a new resistance level at the point of the broken support level. In order to take advantage of this, you have to wait until the price goes back up to the broken support or resistance level and make the trade after the price bounces.
It should be noted that this can be a risky strategy, as there will be times when the price just continues to fall or rise after breaking a support or resistance level. This can be caused by a number of factors, and this is why it is important to use other forms of analysis alongside technical analysis when making trading decisions.
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