Support and resistance levels and supply and demand zones are two trading concepts which are very closely related to one another. They each define points in the market where the price is likely to reverse, and they are both found to be forming all over the charts. The main difference between the two, is that supply and demand zones have a zone in which you can use to look for entries into trades, and support and resistance levels are simply lines which you can monitor for entries into trades.
Although this may only seem like a small difference, it’s actually quite significant, because having a zone you can use to watch for entries is much easier than having a line. That, coupled with the fact that supply and demand zones form less frequently than support and resistance levels, means that overall it’s easier to trade reversals from supply and demand zones than it is support and resistance levels.
But what about if we combine the two ?
What if we combine the preciseness of support and resistance levels with the area aspect of supply and demand zones ?
Wouldn’t we then be able to get pin point entries into supply and demand zone trades ?
Soon you’ll have the answer, but first lets look at what the big problem with support and resistance levels is.
The Problem With Trading Support And Resistance Levels
The main problem with trading support and resistance levels is the fact that the market will often fail to turn exactly on the level itself. A lot of the time it will either move slightly beyond the level before reversing, or will just reverse before actually touching the level. This can make trading support and resistance levels quite a frustrating experience, because you’ll often see the market move towards a level and then reverse just before it touches the level, or it’ll pass through the level first and then start reversing when it looked like it was going to continue moving away from the level.
You almost never have this problem when trading supply and demand zones. The reason why is because the zones themselves gives you an area in which you know the market should reverse in. You don’t really have to worry about a reversal signal forming at an exact point, like you do when trading support and resistance levels, because you’ve got a whole zone you can use to watch for entries into trades. You know that no matter where the reversal signal ends up forming, as long as it’s found to be somewhere inside the supply or demand zone it’s a sign a reversal could be taking place.
Now if you combine support and resistance levels with supply and demand zones you can get the best of both worlds. You can eliminate the issue not knowing if the market failing to touch the level or just moving beyond the level is still a reversal signal, whilst also having a better idea of where a reversal out of the supply or demand zone is likely to take place from in the first place.
The black lines you see here are all the support and resistance levels which had formed inside the demand zone. I found levels these using the support and resistance indicator you can download from this article. “How To Correctly Draw Support And Resistance Levels”
In total you can see there were three support levels inside the demand zone. The market reversed out of the zone after hitting the lower support level found at the 1.05000 round number. If you had marked these levels on your chart before the market dropped into the zone, you could have used them to pin point the place where the reversal out of the zone was likely going to originate from, which could have allowed you to get into a reversal trade really early with a tight stop loss.
Lets take a look at another one.
This zone also contained three support levels which had the potential to cause the market to reverse once it entered the zone. Like in the other example you wouldn’t know which of these levels the market was going to reverse at before the price dropped into it, you would just know that it’s almost certain for it to reverse at one of the levels themselves. In this instance it ended up turning once it hit the support level found at the 1.05900 round number price.
If we go onto the 5 minute chart you can see that when the market hit the support level a couple of bullish engulfing candles began to form. You could have used these engulfing candles to get a buy trade placed to take advantage of the reversal, knowing that any reversal out of the demand zone is likely to begin once the market has hit one of the support levels inside the zone.
Hopefully you can see how marking the support and resistance levels found inside supply and demand zones can allow you to pin point entries into trading positions. What I want to do now, is give you a quick run through of how to use the levels inside the zones to get trades placed, and show you where need to put your stop loss if you’ve managed to get a trade executed.
How To Trade Support And Resistance Levels Inside Supply And Demand Zones
Taking trades when the market hits a support or resistance level found inside a supply or demand zone is very similar to just trading the zones on their own. The way you would commonly trade a supply or demand zone is by having a pending order placed at the edge of the zone ready for when the market returns, or by watching for a price action pattern like an engulfing candle to form on the lower time-frame when the market enters the zone. The fact that you don’t know which support or resistance level inside the zone is going to cause the market to reverse, means that you can’t really use a pending order to enter a trade, so the only other option is to watch for a price action signal to form when the market hits one of the support or resistance levels.
Locate The Support And Resistance Levels Inside The Supply And Demand Zones
The first step is to find out where all the support and resistance levels inside the supply and demand zones are located. This is easily done by first marking the zones on your chart, and then by using the support and resistance indicator to see where the lines are actually located.
All you need to do now is mark the levels closest to the demand zones with black lines, so that when you remove the indicator you’ll still know where the levels are located.
Here you can see I’ve re-drawn the supply zone and demand zones to sit on-top of the nearest support or resistance level. Just make sure that when you’re drawing them, draw them to the nearest whole number. E.g the upper edge of the lower demand zone was originally at 1.0543, and the nearest whole number was at 1.0500, so you would re-draw the zone so it’s sits on-top of this level.
Watch For An Entry When The Market Hits Each Level And Set Your Stop Loss Accordingly
Once you’ve got the support and resistance levels and supply and demand zones marked correctly, you need to begin watching the levels for potential entries into trading positions. The best way of doing this is to switch to a lower time-frame and monitor the price action that forms when the market starts to encounter each of the levels inside the zone.
You can see that when the market hit the first support level a bullish engulfing candle formed and caused a slight move higher to take place. This move ultimately ended up failing and caused the market to fall down to the other support level found below. This support level (support 2), caused another engulfing candle to form and pushed the market above the high of the upswing created when the market hit support level 1. Another downswing then took place and this caused the market to fall below the swing low of the upswing created by the market hitting the second support level.
This final drop did not manage to reach the third support level which made up the edge of the demand zone, and it was only a short time later when the market moved higher again and caused the price to completely reverse out of the zone.
There are two ways in which you could have traded these bullish engulfing candles.
After seeing one of the engulfs form, you could have entered a buy trade with your stop loss placed at the nearest support level, which was either 12 or 17 pips away depending on which bullish engulf you decided to trade. Or you could have entered a trade with a stop placed at the edge of the demand zone itself, which was either 21 or 17 pips away depending on the engulf. Usually having the stop placed at the edge of the zone is the better option, because it will save you from any spikes which may occur after getting your trade placed.
In our example, if you had placed a buy trade with your stop at the nearest support level upon seeing the bullish engulf at support level 1 form, there’s a high chance you would’ve lost money when the up-move failed and caused the market to drop down into support level 2. If you had placed your stop loss at the edge of the demand zone, this wouldn’t have happened, because the market never fell to this point before reversing out of the zone.
Lets take a look at another example.
You can see I’ve marked the support and resistance levels found in and around this demand zone on the chart, and I’ve also re-drawn the zone so that it sits on-top of the s + r levels found closest to the zone itself. Lets now go down to the 5 minute chart to see if there was a price action signal we could have used to get a buy trade placed when the market was inside this demand zone.
On the 5 minute chart we can see that when the market hit the support level found in the middle of the demand zone two bullish engulfing candles formed. The first caused the market to move out of the zone, but did not cause it to reverse completely, whilst the second did cause the market to reverse out of the zone but not before it spiked back in and produced a bullish pin bar. (marked with an X)
Your entry into this trade would be on one of the bullish engulfing candles that formed after the market hit the support level. The second engulf was the one which had a higher probability of being successful, due to the fact it created the second swing low in the reversal (see below), but the first was also fine to trade if you didn’t need any additional confirmation a reversal out of the zone was going to take place.
Your stop loss on either trade would be placed at the support level which makes up the edge of the demand zone, which in this case is around 20 – 25 pips away depending on which engulfing candle you had decided to use to get your buy trade placed.
A small tip I think will help you trading support and resistance levels inside supply and demand zones, is to watch for multiple swings to form with their lows or highs forming around similar prices to one another before entering your trade. Virtually all reversals in the market, no matter what time-frame you see them on, will have at least two swings form with their highs or lows terminating at similar prices to one another before the reversal takes place. In the two examples I’ve shown you, at least two swings formed with their lows at similar prices to one another on the 5 minute chart before the market actually reversed out of the demand zone.
You could use this knowledge to aid you in getting your own trade placed at the levels in the zone.
For example, if you saw the market drop into a zone and produce a bullish engulfing candle, you could hold off placing a buy trade until you see another swing low form at a similar price. Because you know that if the market is in fact going to reverse out of the zone, another swing is going to take place with it’s low forming at a similar point to where the low of previous swing formed at.
Just make sure you remember two things:
- When the market enters a demand zone you want to see at least two swings take place with their LOWS terminating at similar prices to one another.
- When the market enters a supply zone you want to see at least two swings take place with their HIGHS terminating at similar prices to one another.
Take Profits Once The Market Makes New Higher High Or Lower Low
When you’ve got yourself into a profitable trade, and the market has reversed out of the supply or demand zone, the final thing to do is take some profits off the trade, to make sure you don’t end up coming out of the trade with nothing if the price action changes and causes the market to move against your position. I’ve always found that the best time to take profits is after you’ve seen the market make a new higher high, if you’ve got a buy trade placed into the market, or after a new lower low has formed, if you’ve got a sell trade placed.
Exiting the trade always comes down to personal preference in my opinion.
I hope it’s clear from this article how you can use support and resistance levels in conjunction with supply and demand zones to get better entries into reversal trades. Although some issues will no doubt still arise when trading the levels, you can be sure that they will be small when compared with the advantage you gain from being able to pin point the places where reversals out of the zone are likely to originate from.
As always if you have any questions about today’s article please leave them in the comment section below.