How to Draw Support and Resistance Levels (Market Structure)
Hello traders, welcome to the price action course and the first module, introduction to price action trading. In this lesson we are going to wrap everything up and we are going to learn what’s behind the charts and how to understand market structure. When we talk about market structure we are talking about understanding the overall direction of the market, whether we are in an up trend, a down trend, or if we are in a ranging market. And this is very important because we are going to base our trading decisions on market structure and we are going to confirm them with the information that we get from candlesticks.
Let’s start by defining market structure. Price action traders rely on market structure for their trading decisions, either for trend trading or counter trend trading. If we are in the down structure for example, we are going to look for sure opportunities. If this structure breaks meaning that a demand area got rejected and we got a bounce out of it, we are going to look for a long opportunity. First we need to define the current trend. To do this we always look at the higher time frames and the reason we do this is because we don’t want to be trading against the trend. Meaning that if we go to the lower time frames we might get an intraday rally but the overall move might be an aggressive down trend. Meaning that we are going to be trading the long side of an aggressive down move and we are going to be trading against the smart money.
Looking for overall direction on the lower time frames is difficult and confusing because of the intraday noise. Higher highs and lower lows define an up move and you may look for long opportunities in the lower time frames. Meaning that we are always going to be analyzing multiple time frames, meaning that if you like to trade the 4-hour chart for example you might want to look at the daily or the weekly for market direction, and then look for conflictive areas on the 4-hour chart and if you find that on the daily or the weekly you are in an up move you are going to be looking for long opportunities on the 4-hour chart.
And on the contrary, lower lows and higher highs define a down structure, and you may look for short opportunities in the lower time frames. Meaning that if you like to trade the 50-minute chart you might want to look at the 4-hour chart for direction. And if you find that the market is rallying on the 4-hour chart, you can go to the 50-minute chart and then find areas that price might reject and bounce off them to get low on the market. We will always look for inflection points as supply and demand zones to enter the market and always look for confirmation from candlestick formation. Meaning that we are never going to enter in the middle of a move. If we miss an entry near a supply or demand zone we are going to wait for price to reach the next inflection point and then we are going to analyze by section and decide to enter.
We are not going to chase moves, we are not going to chase trades and we are definitely not going to enter blindly in the middle of a move. And this is because if you enter in the middle of a move or if you enter for example price bounces because of a demand zone and the down structure breaks so you are looking for long opportunities. But if you miss the break, and the bounce of that demand zone and a price rallies, 200 peeps and you decide to go long there, you might be getting long at the end of the first wave of the move and you are going to be, first of all, risking a lot of peeps because your stop/loss will always go below the demand zone. And secondly, you’re going to be in a losing position because of price corrections.
Now we are going to go to a live US dollar Japanese yen chart, and we’re going to apply everything we have learned so far on the course. This is the hourly U.S. dollar Japanese yen chart and as you can see, we are going to analyze from early in December to right now mid-January. The first thing we are going to do is look for market direction, and right here at this point, well you can see that market… price wasn’t doing much. It was trapped inside this range and even though we broke to a downside we failed to make a lower low. Thus we can actually… say that we went all the way up to the top of the range. What you need to do first of all if you are trying to short the U.S. dollar Japanese yen, you need to draw the supply zone all the way up here from this high.
Now the supply zone is drawn from this high to this low. This is the base or the actual range where price might hit and bounce from, and you can see that we tested it here once, twice, when we broke to the down side then we kept up during the weekend and that we tested it again three more times before continuing to the down side. After drawing the supply zone we have to draw the demand zone that we are looking at for a break to the down side. We go and grab another rectangle and you can see that the base is from this high to this low right here, okay? And after you draw it you can see that the bottom of this demand zone is the actual bottom of the gap up. Now once you’ve drawn this you need to understand that right here price is doing higher highs and higher lows, okay?
And this is an immediate up move, but we are still without any overall direction, but if you are analyzing the 60-minute chart and you are looking for long opportunities at this point, you might go to the 50-minute chart. But what we’re doing right here is we are waiting for a break of this up structure, and there’s two things you need to understand. First of all, you need to draw the trend line that price is bouncing from. You can see that the trend line start at this low, than you draw it through this low right here, and you have a third, fourth, and fifth test of the same trend line. This is the up structure that we are talking about, the immediate up structure and this is pure price action.
First of all you can see that price is moving up in what seems to be a mildly strong up move and you can see that actually we kept up, and right here we encounter a very strong bearish pressure that made price move all the way down here. But you can see that these… let me just thicken these out for you so you can better see what I am talking about… you can see that this candle right here has a huge down wick and a very small body. And it looks like a pin bar and the interesting thing about this is that price went all the way down here, closed the gap, or the weakened gap, tested the ascending support, failed to break below the ascending support, and failed to close below this demand area, and quickly moved up. What was expected happened. Price moving all the way down here, testing this support zone, closing the gap and moving up.
We continue to play in this very narrow range, but here you have one candlestick that breaks this up structure. As price action traders, we could start a short precision right here, but, we are at a demand area. So we need an actual close below this area right here which is also a round number for us to be able to short this currency pair. We have two kinds of entries that we could apply here. An aggressive entry at the break of this ascending trend line when price started to make higher lows and lower highs which means that price was contracting inside what seems to be a triangle formation and when it broke with the triangle formation, you could have shorted this currency pair with your stops above these highs right here or above the supply area.
Because if we break above this supply zone, this would mean that our trade idea is invalid because this was only a fake out, and price is moving up taking out the sellers at this area right here. But this didn’t happen, and price continued to the down side. When price closes below this area of demand, we have a very nice short opportunity that you can see right here. Price broke extremely aggressive to the downside, then retested the same demand zone only to continue to the down side. This is how you need to read your charts. You need to look for zones that are going to find a lot of buyers or a lot of sellers and you need to look for bounces like in this case, or breakouts like in this case.
In this case, buyers were only waiting for price to close the gap and then they moved the price sharply to the up side. But I think that the bearish pressure or the sellers right here were too strong and when price broke with this structure we were no longer in an immediate up move and we were able to short this currency pair, and you can see right here that we had a second opportunity where price makes this low at this 11820, and then started to move up. Let’s grab the trend line and lets draw a trend line right here. Basically the trend line that we need to draw… this is basic… it looks like very simple trading but if you do not find these important areas where sellers are waiting for price to bounce from, you are not going to be able to take this massive profits or this massive wins.
The second up structure is this one, and this is what we were talking about, we are in a down move. Right here we are not looking for long opportunities because we know that this is just a correction to a very inflictive zone or a very important area which is this one right here. Price started to make higher lows and higher highs. Right here we don’t have a short opportunity yet because price actually made a higher low. But then price came and touched this, previous support level and now resistance and you can see we have a clear rejection, and a clear test right here.
A second test, than a test of the ascending trend line or ascending support and third test of this resistance zone, and then a break out. We have a break up right here and we could actually take a short position when we break with this up structure because… well the actual entry will be around these levels because if you count the highs and the lows, you can see that right here that we have one, right here we have a second one, and a third one right here. When you are looking for breaks of structures you need to look for the actual extreme lows of the move. You cannot count this one as a low or these weeks as low, the actual extreme lows are this one, this is the first one, the second one… after the third high you have another low.
Right here we make a lower low, and once again price started to contract what seems to be a triangle formation because we are making immediate higher lows but we are making lower highs and when we break from this structure we have an aggressive entry at the end of this candle with the stop loss above these highs or way above this resistance zone, or you can wait for the actual break out of this low which would mean that your short position would start right here, but in any case you can see that you have a very nice move to the downside. And the other thing we are going to learn in this course is to look for the velocity of the moves. You can see that price actually took a while to get to this point but it took out of all of these gains very quickly.
And in this case, we also have much more candles to the upside than we have to the downside and we have very long body candles and in this case we also have very long body candles. And when we get to this point right here we can close our position because it’s Friday, you can see that we have the weekend coming up right here and also because price started to condense in this very narrow range. And basically this is what we are looking for in a very simple way when we trade Forex. We are looking for the overall direction, then corrections to the important zones that we drew on our charts and then a break of the structure of the immediate structure too, and we look to trade in the direction of the trend.