In summary, support and resistance are fundamental elements in any financial trade and serve as an indispensable tool to define entry or exit from the trade.
These levels are a consequence of price levels where an asset meets barriers to its movement at each given point, whether it is at a level of support in a downtrend or resistance in an uptrend. The mastery of support and resistance helps traders make better decisions by leveraging but also protecting against the trend in the market.
What are the Levels of Support and Resistance?
Support levels are the levels of price at which an asset tends to find buying interest, preventing it from falling further. At such a price level, traders think it is a good point to enter the trade because the level would hold and the price would start moving upwards. A broken support level may signal further declines since the sellers at that level have outperformed the buying interest.
On the other hand, resistance levels are the price levels where an asset normally meets selling pressure that prevents its further rise. The approaching of the price to resistance usually acts as a signal for traders to close their positions and even open some short positions. If the resistance is overcome, it indicates that buying momentum may be strong enough to drive the price upward and perhaps start a new uptrend.
How to Identify Support and Resistance Levels:
Support and resistance levels can be identified in various ways, using chart patterns, trendlines, and technical indicators.
Historical Price Levels: Past price points where the asset has previously reversed direction often serve as future support or resistance. Reviewing historical data on a price chart can help identify these key levels.
Trendlines: Drawing trendlines along a chart’s highs or lows can reveal areas where the price consistently finds support or resistance. Ascending trendlines typically indicate support, while descending trendlines suggest resistance.
Moving Averages: Technical indicators, such as moving averages, can act as dynamic support or resistance levels. For example, if the price hovers around a 50-day moving average, it may act as support in a bullish trend or resistance in a bearish trend.
Round Numbers: Round figures (like $10,000 for Bitcoin or $100 for a stock) often act as psychological support or resistance levels due to traders’ tendency to place orders around these significant price points.
How to Trade with Support and Resistance Levels?
After you have drawn the levels of support and resistance, now you are ready to incorporate them into your trading to make better decisions in trading.
Entering a Trade at Support: In a bullish market, most traders enter a buy near the levels of support in order to catch the bounce and ride the upward trend. Buying on supports works much better when the level coincides with other indicators, such as moving averages or strong historical price levels.
Take Profits or Short: The resistance levels give you opportunities either to take your profits in an uptrend or to reverse your positions in case you expect a pullback. In contrast, shorting at resistance works very well in a bearish market because it is congruent with the direction of the move.
Confirmation with Breakouts: A breakout, either on the upside over resistance or downside below support, is generally an indication of a stronger trend in that direction. Investors may wait for a breakout above resistance to confirm an upward trend or below support to confirm a downward trend for committing to the trade.
Common Mistakes to Avoid!
While levels of support and resistance are strong tools, they aren’t infallible. Here’s a couple of pitfalls to stay away from:
Over-reliance on Exact Levels: Support and resistance are more often areas than actual points of price. Trading off very rigid levels can result in the stops being tipped off as price fluctuates within these areas before turning around.
Disregarding Market Conditions: Events such as news announcements or a shift in market sentiment can result in support and resistance levels that were otherwise well established to be broken, causing the price action to behave unexpectedly. Always consider the bigger picture.
Final Thoughts:
Both support and resistance levels become tools of great importance to the trader, who desires to manage his trades better and also fine-tune the entry and exit.
Such support and resistance levels are found in chart analysis for traders to better analyze the market and proactively take action if there has been a price movement. It is good to combine support and resistance with other forms of analysis, and to be aware of market conditions in general, which increases effectiveness with respect to trading in general.
