There are different types of support and resistance. We will now talk about a few of them.
Psychological support and resistance
The first type we will talk about is called psychological support and resistance. These regions can only emerge as a result of the human mind’s effort to make sense of the world, without any correlation with any technical formation.
As you are probably aware, the world we live in is quite complex. So we unconsciously try to simplify the world to make sense of our surroundings, and one of the things we do for that is rounding up the numbers. Have you ever wanted 0.7648 apples? Or did you buy 13,678,254 grains of rice from a vendor?
There is a similar effect in financial markets. This is especially true for cryptocurrency trades that contain easily divisible digital units. Buying an asset at $8.0674 and selling at $9.9765 does not have the same effect as buying at $8 and selling at $10. This is why round numbers can also act as support or resistance on a price chart.
But if only it were that simple! This phenomenon has become well known over the years. Thus, some traders may try to “frontrun” in areas of obvious psychological support and resistance. In this case, trading ahead means placing orders just below or above expected support or resistance points.
Let’s examine the example below. As DXY approaches 100, some traders place a sell order just below this level to make sure their orders will be fully executed. As many people expect a trend change at 100 and trade ahead at this level, the market will never reach 100 and the trend changes just below the level.
Trendline support and resistance
If you have read our classic chart patterns article, you know that patterns will also create a barrier to price. In the example below, an ascending triangle pattern holds the price within its structure until it breaks up.
You can use these patterns to your advantage and identify support and resistance zones that coincide with trend lines. It can be beneficial for you especially if you can identify them early, before the formation is fully formed.
Moving average support and resistance
Many indicators can also act as support or resistance when interacting with price.
One of the most obvious examples is moving averages. With a moving average acting as support or resistance for price, many traders use it as a barometer of the overall health of the market. Moving averages can also be useful when trying to identify trend changes or pivot points.
Fibonacci support and resistance
Levels set by the Fibonacci retracement tool can also act as support or resistance.
In the example below, the 61.8% Fibonacci level acts as support many times, while the 23.6% level acts as resistance.
What is the intersection in technical analysis?
Up to this point we have talked about what support and resistance are and the different types. So what is the most effective way to create a trading strategy using them?
An important concept to understand is intersection. The intersection is to create a single strategy from the combination of different strategies. Support and resistance levels tend to be stronger when they fall into more than one of the categories we mentioned earlier.
Let’s examine this through two examples. Which potential support zone do you think is more likely to actually act as support?
Support 1 overlaps with:
- an earlier support zone
- a significant moving average
- 61.8% Fibonacci level
- a round price
Support 2 overlaps with:
- an earlier resistance zone
- a round price
If you read the article carefully, you would have guessed that Support 1 is more likely to hold the price. While this may be true, the price could easily exceed this level. The important point here is that Support 1 is more likely to act as support compared to Support 2. However, nothing is guaranteed when it comes to trades. While trading patterns can be useful, past performances do not represent future performances, so it is necessary to be prepared for all possible outcomes.
In the past, structures that have been validated by multiple strategies and indicators have tended to offer the best opportunities. Some successful traders using intersections can be very picky about the structures they enter, and this often requires a long wait. But when they enter a trade, there is a high probability that the order they set up will work.
Regardless of whether you are trading daily or floating, support and resistance are important concepts to understand in technical analysis. Support acts as the floor for the price and resistance acts as the ceiling.
Different types of support and resistance can be seen and some of them are based on the interaction of price and technical indicators. The most reliable support and resistance zones are those that are usually verified by more than one strategy.
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