the introduction
The concepts of support and resistance are one of the most fundamental topics related to the technical analysis of financial markets. It basically applies to any market, be it the stock market, gold, or cryptocurrencies.
Although they are simple concepts that are easy to understand, they are very difficult to master. Defining them can be entirely a matter of personal vision, but they will perform differently in changing market conditions, and you will need to understand the different types. But above all, you'll need to study a lot of charts, and this guide will help you get started.
What is support and resistance?
At the most basic level, support and resistance are simple concepts. The price finds a level that it cannot break, as this level acts as a barrier of sorts. In the case of support, the price finds a “minimum”, while in the case of resistance, it finds a “maximum”. Basically, you can think of support as a demand area, and resistance as a supply area.
While support and resistance are indicated as lines, the situations on the ground are usually not this level of precision. Keep in mind that markets are not driven by a scientific law of physics that prevents them from breaking a certain level, so it may be helpful to think of support and resistance as areas. You can think of these areas as ranges on a price chart that are most likely to cause increased trader activity.
Let's look at an example of a support level. Notice that the price is constantly entering the area where the asset was purchased, and a support range has been formed with the area retested several times. Since the pessimists (sellers) were unable to push the price further down, it eventually bounced back – potentially starting a new uptrend.
Price bounces into the support area before the breakout.
Now, let's look at an example of a resistance level. As we can see, the price was in a downtrend, but after each bounce, it failed to break through the same area several times. The resistance level is formed because the bulls (buyers) were unable to control the market and push the price higher, causing the downtrend to continue.
The price cannot break through the resistance area.
How traders can use support and resistance levels
Technical analysts use support and resistance levels to identify areas of interest on a price chart. These are levels where the probability of a reversal or pause in the underlying trend may be highest.
Market psychology plays a big role in forming support and resistance levels. Traders and investors will remember price levels that previously saw an increase in interest and trading activity. Since many traders may be looking at the same levels, these areas may bring increased liquidity. This often makes support and resistance areas ideal for large traders (or whales) to enter or exit trades.
Support and resistance are key concepts when it comes to implementing a proper risk management policy, as being able to consistently identify these areas can provide you with profitable trading opportunities. Two things usually happen once the price reaches a support or resistance area: it either bounces away from the area, or it breaks through it and continues the trend – perhaps reaching the next support or resistance area.
Entering a trade near a support or resistance area level can be a useful strategy. This is mainly due to the relatively close cancellation point – where we usually place a stop loss order. If the zone is breached and the trade is cancelled, traders can cut their losses and exit with a limited loss. Thus, the farther the entry is from the supply or demand zone, the further away the cancellation point is.
Another thing to consider is how these levels interact with the changing context. As a general rule, a broken support area may turn into a resistance area when it is broken. On the other hand, if the resistance area is breached, it may turn into a support level later, when it is retested. These patterns are sometimes called support and resistance volatility.
Breaking the support area and turning it into resistance when retested.
The fact that the former support area is now acting as a resistance point confirms this pattern. As such, a retest of the area may be a suitable point to enter a trade.
Another thing to consider is the strength of the support or resistance area. Typically, the more times the price drops and retests the support area, the more likely a breakout to the downside is. Likewise, the more times the price increases and retests the resistance area, the more likely a breakout to the upside is.
Okay, so we've gone over how support and resistance work when it comes to price action, but what other types of support and resistance are there? We will review a few of them below.
Psychological support and psychological resistance
The first type we will discuss is called psychological support and psychological resistance. These areas are not necessarily associated with any art style but exist because of the way the human mind tries to make sense of the world.
If you haven't noticed, we live in an amazingly complex world, so we unwittingly try to simplify the world around us so we can understand it more – and this includes rounding numbers to the largest value. Have you ever thought that you would crave 0.7648 of an apple? Or asked a merchant to buy 13,678,254 grains of rice?
A similar effect occurs in financial markets, and this is especially true for cryptocurrency trading, which involves digital units that are easily divisible. The process of buying an asset at $8.0674 and selling it at $9.9765 is not processed in the same way as buying at $8 and selling at $10. This is why integers can also act as support or resistance on a price chart.
Well, if only it were that simple! This phenomenon has become well-known over the years, and so, some traders may attempt to “pre-empt” obvious psychological support or resistance areas, i.e. place orders directly above or below the expected support or resistance area.
Consider the following example: As the US Dollar Index (DXY) approaches 100, some traders place sell orders just below this level to ensure that these orders are executed. Since many traders expect a reversal at 100 and many try to get ahead of this level, the market never reaches it just before that.
Breaking the support area and turning it into resistance when retested.
The fact that the former support area is now acting as a resistance point confirms this pattern. As such, a retest of the area may be a suitable point to enter a trade.
Another thing to consider is the strength of the support or resistance area. Typically, the more times the price drops and retests the support area, the more likely a breakout to the downside is. Likewise, the more times the price increases and retests the resistance area, the more likely a breakout to the upside is.
Okay, so we've gone over how support and resistance work when it comes to price action, but what other types of support and resistance are there? We will review a few of them below.
Psychological support and psychological resistance
The first type we will discuss is called psychological support and psychological resistance. These areas are not necessarily associated with any art style but exist because of the way the human mind tries to make sense of the world.
If you haven't noticed, we live in an amazingly complex world, so we unwittingly try to simplify the world around us so we can understand it more – and this includes rounding numbers to the largest value. Have you ever thought that you would crave 0.7648 of an apple? Or asked a merchant to buy 13,678,254 grains of rice?
A similar effect occurs in financial markets, and this is especially true for cryptocurrency trading, which involves digital units that are easily divisible. The process of buying an asset at $8.0674 and selling it at $9.9765 is not processed in the same way as buying at $8 and selling at $10. This is why integers can also act as support or resistance on a price chart.
Well, if only it were that simple! This phenomenon has become well-known over the years, and so, some traders may attempt to “pre-empt” obvious psychological support or resistance areas, i.e. place orders directly above or below the expected support or resistance area.
Consider the following example: As the US Dollar Index (DXY) approaches 100, some traders place sell orders just below this level to ensure that these orders are executed. Since many traders expect a reversal at 100 and many try to get ahead of this level, the market never reaches it just before that.
Trend lines act as support and resistance for the S&P 500 Index.
You can use these patterns to your advantage and identify support and resistance areas that correspond to trend lines. These patterns can be particularly useful if you can spot them early, before the pattern has fully developed.
Moving average support and resistance
Many indicators may also provide support or resistance when they interact with the price.
One of the most obvious examples of this is moving averages. Because the moving average acts as support or resistance for the price, many traders use it as a measure of the overall health of the market. Moving averages can also be useful when trying to identify trend reversals or pivot points.
The 200-week moving average is acting as support for Bitcoin price.
Fibonacci support and resistance
The levels shown by the Fibonacci Retracement Tool may also act as support and resistance.
In the following example, the 61.8% Fibonacci level acts as support several times, while the 23.6% level acts as resistance.
Fibonacci levels act as support and resistance for Bitcoin price.
What is coupling in technical analysis?
So far we've discussed the concepts of support and resistance, and some of their different types, but what is the most effective way to build trading strategies around them?
There's a key concept to understand here called coupling. Pairing occurs when a combination of multiple strategies is used together to build a single strategy. Support and resistance levels tend to be strongest when they are grouped into several of these categories we've discussed.
Let us clarify this matter through the following two examples. What potential support area do you think has the highest chance of actually serving as support?
Support 1 Compatible with:
Former resistance area
Moving average is important
Fibonacci level 61.8%
Integer in price
Support 2 Compatible with:
Former resistance area
Integer in price
If you have caught up on what we have explained, you will have correctly guessed that Support 1 has a higher chance of stopping the price. While this may be true, the price may also exceed it. But what we mean here is that the probability of Support 1 occurring is higher than Support 2. However, there are no guarantees when it comes to trading. While trading patterns can be useful, past performance does not necessarily suggest future performance, so you must be prepared for all possible outcomes.
Historically, arrangements confirmed by multiple strategies and indicators tend to provide the best opportunities. Some successful pairing traders may be very selective about the trades they enter – often involving a lot of waiting periods. But when they enter into trading deals, they are more likely to succeed.
Despite this, it is always necessary to manage risk and protect your capital from unfavorable price movements, as even with the strongest arrangements and best entry points there is a chance that things will not go the way you want. It is necessary to keep in mind the possibility of several scenarios, so that you do not fall into the traps of false breakouts or ups and downs.
Concluding thoughts
Regardless of whether you practice day trading or swing trading, the concept of support and resistance is a fundamental concept to understand when it comes to technical analysis. Support acts as a price minimum, while resistance acts as a maximum.
There can be different forms of support and resistance, some of which depend on the price's interaction with technical indicators. Reliable support and resistance areas are often those areas confirmed by multiple strategies.