Understanding the principles of support and resistance can help you improve and your crypto trading performance.
Support and resistance are the bread and butter of technical analysis—they are the most widely used levels in trading.
It would be challenging to form any profitable trading strategy without knowing how support and resistance work. Buying at support (low price) and selling at resistance (high price) is a basic trading principle that necessitates the need to understand the two concepts for profitable trading.
How do support and resistance affect your trades? Keep reading to know more.
Support is a price level where a bearish trend is expected to have a temporal obstruction or total reversal. The level is created by buyers looking to buy a crypto token at a lower price when it is undervalued.
Let's say buyers buy bitcoin (BTC) at price X, making the price of BTC move upward; they will try to defend their position at the price X and potentially add to their positions whenever the price gets back to the X point. Since they were able to push the price of BTC in the first instance that it could not fall below price X, buyers will see such a point as a safe level to add more buy pressure. The buying pressure prevents the price from falling further, creating the temporary barrier known as support.
Resistance is a price level where an uptrend or a bullish move is expected to reverse or have a temporary barrier. The resistance level is usually the point where there are many sell orders.
When an asset is getting overvalued, sellers try to take advantage of it. Buyers would also start to look to exit their positions and take their profits. Some of them might even enter a sell position at the price level. Just like the buying pressure (in the case of support), the selling pressure also forms a barrier typically known as resistance.
Price usually respects support and resistance levels until it breaks them. Traditionally, support and resistance levels are indicated with lines, even though those levels are not precise in real-life situations. It is better to think of support and resistance as zones or areas rather than lines—they are more like a price range in a chart that acts as a wall.
There are many ways of identifying support and resistance levels on a crypto price chart. We can categorize these ways into two: the psychological resistance and support levels that we create by how we think, and the trading indicators that have been built to identify them. We will briefly look at this psychological factor and how two of the numerous technical indicators identify support and resistance.
Round numbers usually serve as resistance and support because prices find it hard to go past them. They are sometimes referred to as psychological support and resistance zones because they do not necessarily correlate with any technical pattern on the chart—they are in our minds.
Many of us prefer to buy things at round prices like $35 and $50 rather than buying at $34.67 or 49.26. This preference triggers us to place orders at round numbers. Having more orders at such points creates price barriers. If many buyers execute a buy order at, say, $50 when the price of a crypto token is falling towards $50, such orders could serve as a wall creating support at that level.
The big players in the forex and stocks market (big banks, big companies, and financial institutions) also deal in round numbers, making these points very important in these markets.
A trendline is particularly useful in trending markets. It identifies areas of support and resistance that coincide with them.
From the chart above, the price keeps bouncing off the trend line (which shows the resistance levels) and presents a selling opportunity at each point. Traders would only have to look for other additional confirmations to place their orders.
A moving average is one of the most popular indicators that traders use in identifying support and resistance. It acts as support or resistance to price. Moving average is also useful in spotting trend reversals or a pivot point on the chart.
The price bounced off the moving average at different points in the chart above. In this case, it helps to identify important resistance levels.
Many other indicators also help identify key levels on the crypto price chart. Taking the Relative Strength Index (RSI), for example, many traders consider four major points:
These levels also serve as resistance and support on their own.
You could use some other technical indicators, line tools, price actions, and many other tools to determine these important price levels—you only have to identify the one that would work best for you.
There are many ways of trading support and resistance. In reality, if you ask 20 traders how they trade support and resistance, you might get 20 different answers. Two things might only be common to most of them, forming the major things people do around support and resistance: traders could place trades after a bounce or after a breakout. We will explain these two concepts below.
One of the major ways of trading using resistance and support is to wait for a price bounce and then get a confirmation to place an order. Since there is a chance that the price would reverse, you might just wait for the reversal and then find some sort of confirmation before taking the trade.
Why wait for a confirmation? A confirmation is necessary because not all support or resistance holds. It is better to confirm if the odds are in our favor before entering any position. We don't want to assume that the price will automatically bounce off our support or resistance level, but we want to see it bounce off and give us some more information before entering into a trade.
Support and resistance levels do not hold at all times—they break often. Such a breakout presents trading opportunities as traders start to look forward to trade at the new price zones. At this point, all we do is wait to be sure the price has broken the points, and then we try to find an entrance when we get more confirmations.
When there is a price breakout, there might be a pullback before the price continues it moves. For example, when support gets broken, there is a possibility for a pullback, some traders call it a 'retest'. The pullback makes the price retrace back to the last broken support, which would have become a resistance, before continuing its move. What we might do to execute a trade is to wait for the pullback and then look for a confirmation to enter. Some traders also enter headlong immediately after a breakout—this is a more aggressive approach.
The old price resistance zones, which have been broken in an uptrend, become the support to which the price might retrace back. The opposite is also true in a downtrend; the broken support acts as resistance which is expected to hold the price.
Support and resistance form the bedrock for technical analysis. They are built into most trading strategies. Price can respect these levels or break the levels. Since the price will not always respect support and resistance levels, you have to put proper risk management strategies in place to limit losses when a trade does not go in your favor.
Identifying support and resistance alone does not guarantee success in trading. It is a basic skill to have as a trader. There are many more trading concepts to learn like price actions, risk management, and trading psychology. You also need to learn various confirmatory strategies to combine with support and resistance before entering into a trade.
You should only make trading decisions after determining the market direction using a combination of tools and not by relying on just one tool. If you do not have the time to learn or master trading, you could get a robot to do the trading for you. This method does not require you to do any analysis.
Temitope is a Writer and Financial Market Trader. He has a special interest in financial technology (FinTech), with experience writing on crypto, NFT, and blockchain topics.
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