General Understanding of Support and Resistance
Support and resistance analysis are the foundation blocks of technical analysis, and many effective trading strategies can be based solely on them. It identifies price levels where historically the price reacted either by reversing or at least by slowing down and prior price behavior at these levels can leave clues for future price behavior. In simple terms, support and resistance are like glass floors and ceilings which appear to limit a market's range of movement.
The reason support and resistance appear is due to the balance between buyers and sellers, or you can say the change of demand and supply. When there are more buyers than sellers in a market (or more demand than supply) the price tends to rise. And when there are more sellers than buyers (or more supply than demand) the price tends to fall.
Support and Resistance levels can be identifiable turning points, areas of congestion, or psychological levels (round numbers that traders attach significance to). For example, a support level occurs when a market that's falling halts its decline to move higher. This typically means that the balance of market participants is moving from a seller's market to a buyer's market. The low point of the move is seen as a level of support. Resistance is the opposite. It is a level where a rising price reverses downward as a shift in the balance of buyers to sellers pushes prices lower. The high point is the resistance level.
Finding Support and Resistance
Areas of support and resistance are relatively straightforward to plot on a chart, you just need to find a level the market has reached, but not been able to breakthrough. The more times the market reaches that level but fails to go through it, the stronger that level of support or resistance is said to be. In fact, major levels of support or resistance can often become psychological barriers, with many traders buying or selling as soon as that level is reached - which serves to reinforce the effect. The higher the timeframe, the more relevant the levels become.
You need to know that major support and resistance levels are rarely exact numbers. It's unusual for a market to hit exactly the same price repeatedly before reversing, the market is hard to predict in every move, so it's probably more realistic to think of them as temporarily support or resistance zones.
From the above chart, you can see that the price often goes past or stops short, of each support or resistance line - no matter how strong they appear to be. When price touches or jumps through support or resistance briefly before reversing, it's called testing the level. As a price reaches support or resistance zone, it will do one of two things—bounce back away from the support or resistance level, or violate the price level and continue in its direction—until it hits the next support or resistance level.
The timing of some trades is based on the judgment of the possibility of whether support and resistance zones will be broken. Whether the price is halted by the support or resistance level, or it breaks through, traders can "bet" on the direction and can quickly determine if they are correct.
The above example shows a constant level prevents an asset's price from moving higher or lower. This static barrier is one of the most popular forms of support/resistance, but the price of assets generally trends upward or downward, so it is not uncommon to see these price barriers change over time. So understanding of trendline is important when learning about support and resistance.
Many experienced traders will pay close attention to the price of an asset as it falls toward the broader support of the trendline because, historically, this has been an area that has prevented the price of the asset from moving substantially lower. For example, as you can see from the movement of Bitcoin in the chart below, a trendline can provide support for an asset for a certain period.
On the other side, when the market is trending go downside, traders will watch for a series of declining peaks and connect these peaks with a downside trendline. When the price approaches the trendline, most traders will watch for the asset to encounter selling pressure and may consider entering a short position because this is an area that has pushed the price downward in the past.
Traders also use the power of various other technical indicators, such as a popular one called Moving Averages, to aid in predicting future short-term momentum, MA could be a great tool for help identifying levels of support and resistance too. As you can see from the chart below, a moving average is a constantly changing line that smooths out past price data while also allowing the trader to identify the support and resistance zone. Notice how the price of the asset finds support at the moving average when the trend is up, and how it acts as resistance when the trend is down.
The moving average line often creates "automatic" support and resistance levels. Most traders will experiment with different time periods in their moving averages so that they can find the one that works best for this specific task. You can click on our articles talk about How to Use Moving Average indicators for more details.
Fibonacci sequence, which could be called "Golden Ratio", and also observed repeatedly in nature, social structure, and even in asset trading chart.
For example, the Fibonacci retracement tool is a favorite among many short-term traders because it clearly identifies levels of potential support/resistance. You can notice in the chart below how the identified levels are barriers to the short-term direction of the price.
- Support is like a glass floor and resistance is like a glass ceiling that restricts a market's movements
- When a market price reaches a support or resistance level but doesn't breakthrough, it's said to be testing the level
- Market psychology plays a major role as traders and investors remember the past and react to changing conditions to anticipate future market movement
- Support and resistance areas can be identified on charts using trendlines and other useful indicators such as Moving Averages, Fibonacci sequence.
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