Technical Analysis: How to Identify Support and Resistance
June 7, 2022
Support and resistance levels are lines that can be drawn on price charts, giving the analyst an indication of the range in which a price is moving. We will find out in particular what happens to the price when it approaches these levels.
What are support and resistance levels?
One of the cornerstones of any trading strategy is a correct reading of the charts. Support and resistance are fundamental and very useful for understanding what the market trend is and how the price may behave.
Support and resistance levels are formed in a completely autonomous way and are actually the sum of the behaviour of all the people operating in a financial market, which is why they also have a strong relevance at a behavioural and psychological level.
Support is the level at which the price, in a bearish phase, stops its fall and potentially bounces back up again.
The support level is very useful because it allows you to understand how the price might behave when close to the level and you can consequently adopt the strategy you think is most appropriate.
Resistance is the opposite of support, it is the level at which a price in a bullish trend finds resistance to its rise and could bounce back down
Again, resistances are extremely useful in a bullish market because they allow you to understand whether the price can still continue to rise or the bullish momentum is running out.
What is support?
Support is formed when the price repeatedly fails to fall beyond a certain level. It needs to be repeated because that means that in a particular price level, the buying outweighs the selling and therefore the price rebounds several times. Generally, the more times this price movement is repeated, the more important and robust the support level will be.
When the price reaches support, 3 main things can happen:
- Rebound – as the name implies, the price goes down until it reaches the support but fails to break it, so it bounces back up;
- Breaking support – the price in this case manages to break the support level and continues to fall. Often, when support is broken, the price falls to the next support level;
- Stationary behaviour – this situation is somewhere between a bounce and a break of support, it occurs when the price stays around the support level and may be slightly above or below it, breaks it but then goes back above and below again;
What is resistance?
Price levels where resistance is created are very important to take into account when the market is in a bullish phase. In fact, very often, when a resistance also corresponds to a historical market high, a situation of ‘price exploration’ is created:
Price exploration, in financial markets, is the situation that occurs when there is a total and free interaction between buyers and sellers. Prices then, once past previous highs, will freely move to new levels.
In the price chart, when the market encounters resistance, 3 things can happen:
- Rebound – again, similar to support, the price fails to break resistance and consequently goes back down;
- Resistance breakout – when the bullish momentum is strong enough, price can break through resistance and continue to rise further;
- Stationary behaviour – if the price does not have enough momentum to continue either in one direction or the other, then it remains stationary around the resistance level;
Finding supports and resistances with trendlines
When you are looking at a chart of Bitcoin or any other cryptocurrency, you can find price levels of resistance and support quite easily. One of the most immediate and easy methods is to draw trendlines, which are straight lines connecting two or more points of the chart. But let’s see an example of a standard support line first.
As you can see, you simply draw horizontal straight lines where you see the price bounce and come back up again. In this case, the blue line is a support level, the price bounced several times
In this other image you can see that according to the trendline method, you can draw not only horizontal lines but also oblique lines. If you want to find support this way, you have to start from a low and look for the next low. If you want to find resistance you have to draw the line from the previous high to the next high. The blue line in the image represents a resistance level. Specifically, the price was rejected twice here by the resistance level.
The psychological factor for support and resistance
A very special feature of both support and resistance is that they are often created where the price is at round numbers, for example 10,000 Euros or 50,000 Euros.
This happens because price movements are strongly influenced by the psychology of individual traders and clearly round figures have a strong impact on the minds of people who suffer from the mechanisms of mental accounting and other cognitive biases. Psychology in financial markets is something real, so the creation of support and resistance is based on tangible, concrete elements.
Around these price levels, many buy and sell orders are usually placed, resulting in a struggle between buyers and sellers, which naturally and automatically creates the typical price movements seen around support and resistance levels.
There are many types of supports and resistances, suitable for different trading styles, but they are all useful for recognising on the chart the most important levels within which price tends to move.