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.
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.
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.
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.
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.
Support and resistance can help you figure out buy or sell signals. Each can either signal a buy or a sell opportunity.
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.
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.
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.
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.