Support and Resistance Levels: Definition and Explanation
Taking a look at crypto exchanges, you may sometimes notice that the price of an asset can "bounce" on certain levels at multiple times. These levels are called support and resistance. These two terms are major technical analysis concepts and play a crucial role in anticipating possible price reversals. In this article, we will define the two terms and explain the market dynamics they result from. We'll then discuss relevant trading strategies using these two concepts.
What is the resistance level?
Resistance is a price level where sellers are stronger than buyers. Sales are strong enough to avoid further price increases. The logic is that as prices move toward resistance, sellers will be more inclined to sell and buyers less inclined to buy. As such, the resistance level can be drawn on the chart using a diagonal or horizontal trendline or a price zone. It is drawn above the price, as if it prevented it to go above it. It "resists" the price uptrends, hence its name.
Once the price has reached the resistance level, supply often takes over from demand and the price should not break through the resistance level. This causes the price to bounce on the resistance before generally going back downwards. But resistance is not always maintained. A break of resistance indicates that buying pressure is greater than selling pressure. It can both be interpreted as a new buying inclination by the bulls or a lack of motivation on the side of the bears. A break of resistance and new highs suggest that buyers have revised their expectations upward and are willing to buy at higher prices. Once the resistance line or resistance area is broken, the next resistance level should be set at a higher level.
The example above is drawn from the BTC/BUSD market on Binance, on 1-hour candlesticks. The asset went on a bullish phase, and the price peaks form an upward line, the resistance. Whenever the price hit the resistance line, it bounced back down, before going up again, above its previous peak. On the example above, the resistance line is tested four times, but never broken. The fourth failure to break it might have caused the market to enter a bearish phase.
What is the support level?
Support is a price level where buyers are stronger than sellers. Buyers are strong enough to avoid further price declines. As the price moves towards the support level, or the support zone, buyers will buy more and sellers will sell less. This naturally prevents the price to drop below the support zone, and causes the it to bounce back up. The support zone figuratively maintains or supports the price above a certain level, hence its name.
However, just like resistance, support does not always block the price and a break of the support suggests that the bears have regained control over the bulls. A break of support indicates a new selling bias on the part of bears and/or a lack of demand on the part of buyers. A break of support and new lows suggests that sellers have lowered their expectations and are willing to sell at lower prices. The price has failed to bounce back on the support level, which confirms a bearish phase. Similar to a break of resistance, once the support line or support zone is broken, the next support level should be set at a lower level.
The example above is drawn from the BTC/BUSD market on Binance, with 1-hour candlesticks. The asset seems to be on a stabilization phase, and its price cannot seem to go below the support zone. Whenever it approaches it, buying tension exceeds selling tension, causing the price to bounce back up.
How to find resistance and support levels?
Resistance and support levels are technical analysis concepts rather than technical analysis indicators. As such, they cannot be accurately calculated with a given formula. Traders need to study the market and identify them visually. It is sometimes necessary to change the scale of the timeframe of the chart to be able to spot them.
Also, they shouldn't be thought of as razor-sharp precise visual cues. Resistance levels are usually above the current price, but the stock can often trade at or near the resistance level. Volatile price movements can temporarily break through the resistance level. Volatile prices can sometimes break the resistance level briefly before falling back under it. In that case, the resistance shouldn't be invalidated.
Support levels are usually lower than the current price, but it is not unusual for the price to trade at or near support as it is also the case for resistance levels. Just like resistance levels, it also possible for some volatile price movements briefly break the support level or the support zone, without invalidating it. As you can see on the example above, the price briefly breaks through the support zone, before quickly going back above it.
Using moving averages as resistance and support
Remember that technical analysis is not an exact science. It is based on the market psychology. Support and resistance levels follow that idea since they are based on buyers' and sellers' intentions. The key factor in finding accurate resistance and support levels is to efficiently predict where sellers will outsell buyers and where buyers will outbuy sellers. Moving averages being an extremely popular indicator in technical analysis, many traders place their buy and sell orders around them. Remember that the market is considered bullish if the price is above the moving average. In that case, the moving average can provide the support level. On the contrary, on a bearish market, moving averages can provide the resistance level. The challenge is to figure out which moving average and what period will provide the most accurate support and resistance level in which situation.
This chart is drawn from Binance's BTC/BUSD market, on 30 mins candles. We have drawn the 25-period simple moving average in orange. The market is initially bullish, and tests several times the moving average - the support level - before clearly dropping below it on the right hand side of the picture. That drop made the market bearish.
How to trade using resistance and support levels?
Support and resistance can help you figure out buy or sell signals. Each can either signal a buy or a sell opportunity.
Selling at resistance
Resistance levels are meant to predict where the price will bounce back down, and anticipate strong selling tensions. As such, it can be wise to sell whenever the prices hits the resistance level for the third or fourth time, to anticipate a drop.
As you can see on the chart above (ETH/BUSD market from Binance on 15-min candlesticks), the resistance zone is identified at the second bounce. A sell could occur when the resistance enters the resistance zone for the third time.
Buying on support
Support level are meant to identify where price levels at which the asset's value can't go lower. Thus, traders can buy on support levels, expecting the price to bounce back up.
Buying resistance breakouts
Resistance are not always able to lock in the price and the stock can simply break these levels. It is also possible to profit by buying these breaks. A breakout from an horizontal resistance level often confirms an uptrend.
Selling support breakouts
Support lines are also subject to breakouts. A breakout from the support level can confirm a downtrend, and can be considered as a time to sell or short.
The example above is drawn from the ETH/BUSD market on Binance, 1h candlesticks. The price failed to bounce a fourth time on the support line, and broke out. A strong downtrend followed. Selling or going short would have been a good decision.
Combining Support and Resistance Levels with Other Indicators for Enhanced Trading Signals
Support and resistance levels are fundamental concepts in technical analysis that help traders identify potential price reversals and manage risk. To improve the effectiveness of your trading strategy, it's essential to combine support and resistance levels with other technical indicators. This approach provides more robust signals and helps to filter out false breakouts or reversals. Here are some popular indicators that you can use alongside support and resistance levels:
Moving Averages can act as support and resistance levels
Moving averages (MAs) are widely used to identify trends and potential support and resistance levels. Simple Moving Averages (SMA) and Exponential Moving Averages (EMA) are the two most common types of moving averages. When the price is above the MA, it can act as a support level, while it acts as a resistance level when the price is below the MA. Combining MAs with horizontal support and resistance levels can strengthen your trading signals and provide dynamic levels for potential reversals.
Fibonacci Retracements are useful in identifying support and resistance levels
Fibonacci retracements are based on the mathematical Fibonacci sequence and are used to identify potential support and resistance levels within a trend. By drawing a Fibonacci retracement tool from a significant low to a significant high, you can identify key retracement levels (usually 23.6%, 38.2%, 50%, 61.8%, and 78.6%) where the price may reverse. Combining these levels with traditional support and resistance levels can provide confluence zones where the probability of a price reversal is higher.
RSI (Relative Strength Index) to confirm signals
The RSI is a momentum oscillator that measures the speed and change of price movements on a scale of 0-100. When the RSI is above 70, it indicates overbought conditions, and when it's below 30, it indicates oversold conditions. Combining RSI with support and resistance levels can help you identify potential reversal points in the market. For example, if the price reaches a support level and the RSI is in oversold territory, it can provide a strong buy signal.
MACD (Moving Average Convergence Divergence) to confirm signals
The MACD is a trend-following momentum indicator that shows the relationship between two moving averages of a security's price. It consists of the MACD line, the signal line, and the histogram. When the MACD line crosses above the signal line, it generates a bullish signal, and when it crosses below the signal line, it generates a bearish signal. Combining MACD signals with support and resistance levels can help confirm potential trade entries and exits.
Volume to spot fake and genuine breakouts
Analyzing trading volume is crucial when using support and resistance levels. Increased volume near a support or resistance level can indicate that the level is more likely to hold. On the other hand, a breakout accompanied by high volume can be a strong indication that the breakout is genuine and not a false signal.
When combining support and resistance levels with other indicators, always remember that no single indicator or tool guarantees success in the market. The objective is to use multiple indicators to filter out false signals and increase the probability of successful trades. Make sure to employ proper risk management techniques and position sizing to protect your capital.
Frequently Asked Questions on Support and Resistance Levels
What are support and resistance levels?
Support and resistance levels are technical analysis concepts used by traders to predict potential price reversals in the market. A support level is a price level where buying pressure overcomes selling pressure, preventing the price from falling further. A resistance level is the opposite, a price level where selling pressure overcomes buying pressure, preventing the price from rising further. These levels are used to make informed trading decisions and manage risk.
How are support and resistance levels determined?
Support and resistance levels can be determined using historical price data and technical indicators. Traders look for recurring price patterns where the price has reversed, consolidated, or experienced increased trading volume. Key psychological price levels, moving averages, and Fibonacci retracements are some tools used to identify potential support and resistance levels.
Why are support and resistance levels important in cryptocurrency trading?
Support and resistance levels help traders identify potential entry and exit points for trades, manage risk, and set stop-loss and take-profit orders. They provide a framework for understanding market sentiment and price movements, which can be particularly useful in the highly volatile cryptocurrency market.
Can support and resistance levels be broken?
Yes, support and resistance levels can be broken if the market sentiment or fundamentals change significantly. A breakout occurs when the price moves beyond a support or resistance level with strong momentum, indicating a possible continuation of the trend. A false breakout or a fakeout can also happen, where the price moves beyond the level temporarily but then reverses back to the previous range.
What is a support or resistance zone?
A support or resistance zone is an area, rather than a single price point, where the price tends to reverse or consolidate. This zone represents a range of prices where buying or selling pressure is strong enough to influence the market. Considering zones rather than exact levels provides a more flexible approach to support and resistance, acknowledging that price action can be unpredictable and messy.
How can I use support and resistance levels in my trading strategy?
Incorporate support and resistance levels in your trading strategy by identifying potential trade setups, setting stop-loss and take-profit orders, and managing risk. For example, a trader might buy near a support level, expecting the price to bounce back up, and set a stop-loss below the support to minimize potential losses. Similarly, a trader might sell near a resistance level, expecting the price to reverse, and set a stop-loss above the resistance.
Are support and resistance levels more effective in certain market conditions?
Support and resistance levels tend to be more effective in ranging markets when the price is oscillating between support and resistance levels. In strong trending markets, support and resistance levels may be less reliable, as breakouts and strong momentum can lead to price movements beyond these levels.