Support & Resistance Trading Indicators
Support and Resistance
Support and resistance refer to the price levels on financial charts at which the prevailing trend is expected to pause or move in the opposite direction due to the collision of forces of supply and demand.
The support and resistance concept is used in technical analysis to predict an asset's future price dynamics and determine the best entry or exit points for trades.
The asset price surpassing an established support or resistance level leads to the formation of a new one.
A support price level appears in a downtrend when price declines are stopped by a concentration of buying interest. As the asset price moves down, demand begins to increase, creating a support line.
A resistance level is the value on a chart above which prices are unable to move due to selling pressure. When an asset in an uptrend faces increased selling interest, a resistance line is formed.
Principle of polarity
According to the principle of polarity, if the support or resistance level is broken it is likely to reverse its role. Once surpassed, the former resistance level turns into a floor for the subsequent downtrend. The broken support level takes on the role of ceiling for further possible upwards price movement. The polarity principle is born out of shifts in supply and demand.
Psychology of Support and Resistance
Support and resistance levels identify the price points on a chart past which prices are unlikely to move at the present time. They are largely determined by market sentiment and work in accordance with human psychology. Traders tend to both remember the past state of the market and adapt to its changing conditions.
In financial markets there are typically 3 types of participants at any price level: traders in long positions, traders in short positions and traders who have not yet decided to enter a position. The following table demonstrates how buying and selling pressure is created at support and resistance levels respectively.
|Price rises from support (buying pressure)||Price goes down through support, support becomes resistance (selling pressure)|
|Traders in long positions||Anticipate price return to buy more||Wait for the price to climb back above support (new resistance) to sell to cover losses|
|Traders in short positions||Look at a support level as an exit point at which they will “buy to cover” to minimize losses||Anticipate price return to add to their position (sell short)|
|Traders, who have not yet decided||Expect price return to buy in as they see proven investment profitability||Anticipate price recovery to enter into a short position in an assumption that it could fall down even further later on|
Example of Resistance Becoming Support
In December 2021 Stellar (XLM) had a support level near $0.25 that held for about six weeks. XLM/USD entered into a downtrend on January 13, 2022 and hit the low point of $0.16 on January 22, 2022. Once the old support level was broken it became new resistance.
Example of Support Becoming Resistance
In February 2021 Cardano (ADA) had resistance at around $1.40. During price increases in March 2021 ADA/USD did not rise considerably above this level. In early May the resistance level was broken, and on May 16 the pair reached $2.40. In this instance, the old resistance level for ADA/USD became new support.
How to Use Support and Resistance Indicators
Support and resistance indicators are used in technical analysis to establish the points at which the current price trend is expected to pause or reverse.
A moving average (MA) indicator shows the smoothed price action for a specified period of time. Moving averages for different time frames can be used to determine short-term and long-term support and resistance zones.
Fibonacci retracements are the most widely used support and resistance indicator in technical analysis. They take two extreme points on a chart and split the vertical distance between them into key Fibonacci ratios: 23.6%, 38.2%, 50%, 61.8%, and 100%. For each level, a horizontal line is drawn, denoting possible support and resistance levels.
Support and Resistance FAQs
What is the difference between support and resistance?
Support appears in a downtrend and indicates the price level at which the downtrend is expected to pause due to a concentration of demand. Resistance occurs in an uptrend and shows the upper bound past which the asset price is unlikely to move due to selling pressure.
What is a support and resistance strategy?
A support and resistance strategy is a method of chart analysis established to determine the best entry and exit points for trades.
Does support and resistance really work?
Identifying support and resistance is an effective way to predict the future direction of the market. Support and resistance levels identify at which points in time the forces of supply and demand meet.