List of contents
Introduction
What is support and resistance?
How traders use support and resistance levels
Psychological support and resistance
Trendline support and resistance
Support dan resistance moving average
Support dan resistance Fibonacci
What is meant by confluence in technical analysis?
Closing
Introduction
The concept of support and resistance is the most fundamental topic related to technical analysis of financial markets. Applies to every market, be it stocks, forex, gold or cryptocurrencies.
Although it seems simple to understand, this concept is actually quite difficult to master. The process of identifying both can be very subjective, Support and resistance work differently in changing market conditions, in addition, traders must also understand the types. But above all, you have to study a lot of charts. This guide will help you.
What is support and resistance?
At the most basic level, support and resistance are simple concepts. The price finds an unbreakable level, this level acts as a kind of barrier. At support, the price reaches the floor or "floor", while at resistance, the price reaches the ceiling or "ceiling". Basically, you can think of support as a demand zone and resistance as a supply zone.
More traditionally, support and resistance are indicated as lines, but in the real world it is usually not that precise. Please remember; markets are not driven by physical laws that prevent them from breaking through certain levels. This is why it may be more useful if we describe support and resistance as planes or areas. You can think of these areas as ranges on the price chart that are likely to encourage increased activity by traders.
Let's look at an example of a support level. Notice that the price continues to enter the area where the asset was purchased. A support range forms as the area is retested several times. And because the bears (sellers) are unable to push the price further down, it eventually bounces – potentially starting a new uptrend.
Price bounces in the support area before breaking out.
Now let's look at the resistance level. As we can see, the price is in a downtrend. However, after each bounce, the price failed to penetrate the same area several times. Resistance levels are formed because bulls (buyers) cannot control the market to push prices higher, causing the downtrend to continue.
Price was unable to penetrate the resistance area.
How 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, the probability of a reversal or break in the underlying trend will be higher.
Market psychology plays a big role in the formation of support and resistance levels. Traders and investors will remember previous price levels that increased trading interest and activity. Since many traders may be looking at the same level, this area may bring increased liquidity. These circumstances often make support and resistance zones ideal opportunities for large traders (or whales) to enter or exit positions.
Support and resistance are key concepts in carrying out proper risk management. The ability to consistently identify these zones can present profitable trading opportunities. Typically, two things can happen once the price reaches a support or resistance area. Price bounces away from the area, or breaks through it and continues moving in the direction of the trend – potentially to the next area of support or resistance.
Entering trades around support or resistance levels may be a profitable strategy. Especially because it is relatively close to the cancellation point or invalidation point – the place where we usually place a stop-loss order. If the area is broken and the trade is cancelled, the trader can take a cut loss and exit with a small loss. In this case, the further the entry is from the supply or demand zone, the further the cancellation point is.
Another thing to consider is how these levels react to changes in context. As a general rule, a broken support area can turn into a resistance area when broken. Conversely, if the resistance area is broken, it may later turn into a support level when retested. This pattern is sometimes called a support-resistance flip.
The support area was broken and turned into resistance when retested.
The fact that the previous support zone acts as resistance now (or vice versa) proves the correctness of this pattern. Thus, a retest of the area can be a profitable place to enter a position.
Another thing to consider is the strength of the support or resistance area. Typically, the more often the price falls and retests a support area, the greater the likelihood of a breakout below. Likewise, the more frequently the price rises and retests the resistance area, the more likely it is to break out to the upside.
Now, we know how support and resistance work on price action. The next question, what types of support and resistance are there? Let's discuss some of them.
Psychological support and resistance
The first type we will discuss is called psychological support and resistance. These areas do not necessarily correlate with any technical patterns, but exist because of the way humans try to make sense of the world.
If you haven't noticed, we live in a very complicated world. Because of this, we inadvertently try to simplify the world around us, so that we can better understand it – this includes rounding numbers. Have you ever thought about having 0.7648 apples? Or buy 13,678,254 grains of rice from a trader?
Similar effects also occur in financial markets. This is especially true in cryptocurrency trading, which involves digital units that are easily divisible. Buying an asset for $8.0674 and selling it for $9.9765 is not processed the same as buying it for $8 and selling for $10. This is why round numbers can also act as support or resistance on price charts.
Well, it turns out it's not that simple! This phenomenon has been well known for many years. Given these conditions, some traders may try to “frontrun” clear psychological support and resistance areas. In this case, frontrunning means placing orders just above or below a support or resistance area.
Observe the example below. As the DXY approaches 100, some traders place sell orders just below that level to ensure their orders are filled. Because so many traders expect a reversal at 100, and many frontrun at that level, the market never reaches it and instead reverses before reaching that number.
US Dollar Index (DXY) reverses before reaching 100.
Trendline support and resistance
If you have read our article on classic chart patterns, you will already know that patterns will also act as barriers to price. In the example below, the ascending triangle limits price until the pattern breaks upwards.
Trend lines act as support and resistance on the S&P 500.
You can use these patterns to your advantage and identify support and resistance areas that coincide with trend lines. This can be very useful if you manage to spot it early, before the pattern develops.
Support dan resistance moving average
There are also many indicators that can provide support or resistance when interacting with price.
One of the most obvious examples, moving average. Because moving averages act as price support or resistance, many traders use them as a barometer of overall market health. Moving averages are also useful when trying to find trend reversals or pivot points.
The 200-week moving average acts as support for Bitcoin price.
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Support dan resistance Fibonacci
The levels outlined by the Fibonacci retracement tool can also act as support and resistance.
In the example below, 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 meant by confluence in technical analysis?
So far, we have discussed what support and resistance are, and some of their types. Now, what is the most effective way to build a trading strategy?
The important thing to understand is a concept called confluence. Confluence is a combination of several strategies used together to create one strategy. The strongest support and resistance levels usually occur when support and resistance meet several categories that we discussed previously.
Let's imagine through two examples. Which potential support zone do you think has a higher chance of actually acting as support?
Support 1 coincides with:
previous resistance area
moving average is important
level Fibonacci 61,8%
prices in round numbers
Support 2 coincides with:
previous resistance area
prices in round numbers
If you pay attention, you will correctly guess that Support 1 has a higher chance of holding the price. While this may be true, prices can also fly beyond it. The point here is that the probability of Support 1 acting as support is higher than Support 2. However, there are no guarantees. While trading patterns can be helpful, past performance does not imply future performance, so, you must be prepared for all eventualities.
Historically, setups confirmed by multiple strategies and indicators tend to provide the best opportunities. Some successful confluence traders may be very picky about what settings they enter – and this process usually takes a lot of time to wait. However, when entering a trade, their setup tends to work with high probability.
However, it is always important to manage risk and protect your capital from unfavorable price movements. Even a very strong looking setup with the best entry point has a chance of ending badly. It is important to consider the possibility of several scenarios, so that you do not fall into a false breakout or a bull and bear trap.
Closing
Regardless of whether you day trade or swing trade, support and resistance are basic concepts to understand when it comes to technical analysis. Support acts as a floor for price, while resistance acts as a ceiling.
Support and resistance take different forms, and some of them are based on the interaction of price with technical indicators. The most reliable support and resistance areas are those that are usually confirmed by various strategies.
If you want to read more about chart analysis, check out 12 Popular Candlestick Patterns Used in Technical Analysis.
