Playing The Re-Test of Support & Resistance

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Frustration is watching an asset you trade break above a major resistance level or below a major support level and not being in the trade. You do not want to chase the trade, but you do not want to miss it either. What to do? Wait for the retest.

This is a technical pattern that forms as the price of a currency pair, or other financial market moves back to test a former support or resistance level before resuming the new trend that began with the breakout. Often, a former support level will reverse its role and act as a new resistance level after the price has broken down and through the initial support level. The opposite is also true. A former resistance level will frequently reverse its role and act as a new support level after the price has moved up and through the initial resistance level.

The Psychology 

Retests occur when traders want to confirm that a breakout is indeed the beginning of a new trend and not just a fake-out. This is how it plays out:

A Re-Test of support and resistance
Re-Test of Resistance Example.

1. After the initial breakout occurs and the stop losses that were placed above resistance (below support) have all been cleared out, some traders look to take profits just in case the move is not going to last.

2. This process starts pulling the price back toward the support (resistance) level that was just broken. i.e, Demand at these lower prices has started to wane and buyers come back into the market at increasingly higher prices.

3. As the price gets closer to the original break-out level, traders who didn't get into the trade on the initial breakout and have vowed to get in if the price ever came back to that level— or traders who were in the trade at the initial breakout but want to add to their positions— place new entry orders just below the former support level (above the former resistance).

4. This new shorting pressure at ever decreasing prices (or buying pressure at ever increasing prices) will cause the price to turn back around and resume the trend that started with the initial breakout.

Re-Test in action

Recently, the euro/dollar currency pair broke be- low a support level at 1.38. This uptrending level had been serving as support for EUR/USD for about five or six weeks—from the beginning of October 2010 through the first week of November 2010. During that time, EUR/USD dropped to and bounced off of that level two times. On the third bounce, EUR/USD broke down and through the support level. Naturally, this would have been a great time to be short the pair. Unfortunately, if you were not already short the euro/dollar, you were left asking yourself, do I get in now or am I just chasing the trade at this point? Luckily, as is often the case, the price of EUR/ USD turned around and moved higher to retest its former support level. Sure enough, the former support level turned into new resistance, and the EUR/USD moved downward and resumed its new downtrend.

To Sum Up

Will a market always retest a level it has broken through? No. Sometimes playing the retest will cause you to miss some moves, but doing so definitely puts the odds in your favour.

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Frustration is watching an asset you trade break above a major resistance level or below a major support level and not being in the trade. You do not want to chase the trade, but you do not want to miss it either. What to do? Wait for the retest.

This is a technical pattern that forms as the price of a currency pair, or other financial market moves back to test a former support or resistance level before resuming the new trend that began with the breakout. Often, a former support level will reverse its role and act as a new resistance level after the price has broken down and through the initial support level. The opposite is also true. A former resistance level will frequently reverse its role and act as a new support level after the price has moved up and through the initial resistance level.

The Psychology 

Retests occur when traders want to confirm that a breakout is indeed the beginning of a new trend and not just a fake-out. This is how it plays out:

A Re-Test of support and resistance
Re-Test of Resistance Example.

1. After the initial breakout occurs and the stop losses that were placed above resistance (below support) have all been cleared out, some traders look to take profits just in case the move is not going to last.

2. This process starts pulling the price back toward the support (resistance) level that was just broken. i.e, Demand at these lower prices has started to wane and buyers come back into the market at increasingly higher prices.

3. As the price gets closer to the original break-out level, traders who didn't get into the trade on the initial breakout and have vowed to get in if the price ever came back to that level— or traders who were in the trade at the initial breakout but want to add to their positions— place new entry orders just below the former support level (above the former resistance).

4. This new shorting pressure at ever decreasing prices (or buying pressure at ever increasing prices) will cause the price to turn back around and resume the trend that started with the initial breakout.

Re-Test in action

Recently, the euro/dollar currency pair broke be- low a support level at 1.38. This uptrending level had been serving as support for EUR/USD for about five or six weeks—from the beginning of October 2010 through the first week of November 2010. During that time, EUR/USD dropped to and bounced off of that level two times. On the third bounce, EUR/USD broke down and through the support level. Naturally, this would have been a great time to be short the pair. Unfortunately, if you were not already short the euro/dollar, you were left asking yourself, do I get in now or am I just chasing the trade at this point? Luckily, as is often the case, the price of EUR/ USD turned around and moved higher to retest its former support level. Sure enough, the former support level turned into new resistance, and the EUR/USD moved downward and resumed its new downtrend.

To Sum Up

Will a market always retest a level it has broken through? No. Sometimes playing the retest will cause you to miss some moves, but doing so definitely puts the odds in your favour.

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