Support and resistance basics is one of the most important topics in the technical analysis of financial markets. These two concepts apply to almost all markets such as stocks, forex, gold or cryptocurrencies.
Although these concepts are easy to understand, it is quite difficult to master. They can be determined purely subjectively, operate differently in changing market conditions, and their different types need to be understood. But beyond all that, you need to work on a lot of graphics. With our guide, we’ll help you get started with these concepts.
What is support and resistance?
At the most basic level, support and resistance are simple concepts. The price reaches a level that it cannot exceed, and this level acts as a kind of barrier. At support, the price catches a “bottom” and at resistance, a “ceiling”. In its simplest form, you can think of support as a demand zone and resistance as a supply zone.
Although support and resistance are traditionally shown as lines, real-world examples are not so precise. It should be noted that markets are not driven by a law of physics that prevents them from exceeding a certain level. Therefore, it is more useful to think of support and resistance as a zone. You can think of these zones as ranges on the price chart that lead to more activity in traders.
Let’s examine an example of a support level. You can see that the asset is constantly entering an area that leads to an increase in its purchases. A support range is formed by testing the area more than once. And as the bears (sells) fail to push the price any further, the price eventually bounces off, potentially starting a new uptrend.
Now let’s take a look at the resistance level. As you can see the price is in a downtrend. But when the price goes up, it bounces off and has trouble breaking through this area more than once. As the bulls (buyers) cannot take control of the market and cannot push prices higher, a resistance level is formed and the downtrend continues.
How can traders use support and resistance levels?
Technical analysts use support and resistance levels to identify areas of interest on a price chart. At these levels, a change or a pause in the trend may be more likely.
Market psychology plays a huge role in the formation of support and resistance levels. Traders and investors will remember previous price levels where there was more interest and trading activity. Liquidity increase can be seen in these regions as many traders will face the same levels. This makes support and resistance zones an ideal location for entry and exit for large traders (or whales).
Support and resistance are key concepts for successful risk management. Being able to consistently identify these zones can offer profitable trading opportunities. Two things can usually happen when the price reaches a support or resistance zone. Price either bounces off this zone or continues to move in the direction of the trend (possibly until the next support or resistance zone) by crossing the zone.
Entering a trade near a support or resistance zone is a useful strategy. This is mainly because the invalidation point, where a stop-loss order is usually placed, is relatively close. If the zone is crossed and the trade is voided, the trader can exit the trade with a small loss. In this context, the farther the entry point is from the supply or demand region, the farther the invalidation point is.
Another point to consider is how these levels will respond to the changing context. As a general rule, a broken support zone can turn into a resistance zone. Conversely, if a resistance zone is broken, it can become a support level when retested later. This formation is sometimes called a support-resistance change.
The earlier support zones now act as a resistance zone (or vice versa) confirming the pattern. So retesting the area can be a profitable place to enter a position.
The strength of the support and resistance zones should also be considered. Generally, the higher the number of times the price falls and tests the support area, the more likely it is to break the support and continue its downward move. Similarly, the more the price goes up and tests the resistance zone, the higher the probability that the resistance will be broken and the price will continue to rise.
Now we know how support and resistance work for price action.
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