Properly identifying support and resistance levels can probably be the difference between a successful trade and significant losses.
Trading should just be a simple process of buying low and selling high, but for many investors, the process is more like rocket science.
One of the most basic and easiest to understand strategies that can help you do this is to identify an asset’s support and resistance levels.
Once traders can identify support and resistance levels, they can improve their time to enter and exit the market. Support and resistance levels are also useful during bullish, bearish, and ranging markets.
Let’s take a moment to understand the basics.
What are supports?
Support is formed at a level where demand from buyers absorbs supply from sellers, preventing the price from falling further.
At this level, bullish traders tend to buy, believing the price is attractive enough and it may not fall further.
On the other hand, bears stop selling because they believe the market has gone down enough and it could be due to a rally. When both of these situations occur, a support is formed.
The chart above is a good example of strong support. Every time EOS price falls to the $2.33 level, buyers are increasing and selling is decreasing. This causes demand to exceed supply, leading to a recovery.
While horizontal supports are considered more reliable, they are not the only way to form supports. During uptrends, trendlines act as supports.
Litecoin (LTC) started its rally in December 2020. After that, the price bounced off the trendline several times.
This happened as the bulls bought as the price neared the trendline, believing that the LTC/USDT pair had reached attractive buy levels.
At the same time, countertrend traders have halted their selling on the assumption that short-term overselling may occur.
Both occurred simultaneously and led to the end of the correction and the resumption of the uptrend.
What are resistance levels?
Resistance can be viewed as the opposite of support as it is the level where supply exceeds demand and the upward movement stops.
Resistance forms as buyers who have been buying at lower levels start to take profits and aggressive bears start selling as they believe the rally is extending and poised for a pullback. When supply exceeds demand, the rally halts and reverses.
Support or resistance does not have to be at the same level. The chart above shows how the area between $10,500 and $11,000 acted as a resistance zone.
Whenever the price touched this zone, short-term traders took profits and aggressive bears sold the BTC/USDT pair. Between August 2019 and July 2020, the pair broke from the resistance zone five times.
Similar to support, the resistance line or zone doesn’t always have to be horizontal.
During the decline from May 6, 2018 to July 4, 2018, Ether (ETH) rose to the resistance line, also known as the downtrend line, but fell from there.
This is because traders who had a bearish outlook used rallies to open new short positions as they anticipated lower levels.
At the same time, aggressive bulls who bought sharp dips closed their positions near the resistance line. Thus, the line acted as a wall and the price went down.
How to identify support and resistance in consolidation phases
When support and resistance are well defined, as in the EOS/USD pair above, traders can buy on a support bounce and wait for the price to recover near resistance to exit the position. The stop loss for trading can be kept just below the range support.
Professional traders can try chasing these stops multiple times by dragging the price below the range support.
Therefore, traders can buy on the rally and also wait for the price to close decisively below the support before exiting their positions.
How to trade supports in an uptrend
When an asset finds support at an uptrend line three times, traders can expect the line to hold. Therefore, long positions can be taken on a bounce from the uptrend line. Trading stops can be placed just below the trend line.
However, in an uptrend, a break below the trendline does not necessarily mean that the trend has reversed. Often the trend just pauses before picking up again.
As seen in the chart above, the ETH/USDT pair has found support at the uptrend line on multiple occasions.
However, when the pair breached the uptrend line, it did not start a new downtrend. The price consolidated in a range for a few days before continuing the upward move.
Traders can close their long positions if the price falls and stays below the uptrend line, but further short positions should be avoided.
If the price resumes its uptrend after consolidating, traders can start looking for buying opportunities again.
When resistance turns into support
When the price breaks the resistance, the bulls try to turn the previous resistance into support. When this happens, a new uptrend will start or continue. If this happens multiple times, it can present a good buying opportunity.
Bitcoin was stuck between the $10,500-$11,000 zone from August 2019 to July 2020.
After breaking out of the resistance zone, the price dipped below $10,500 again but the bulls bought the dip aggressively and turned the level into a support.
This provided traders with a good buying opportunity as the new uptrend was just beginning.
When support becomes resistance
The Polkadot (DOT) chart above shows how the zone between $28.90 and $26.50 acted as a support zone from February 14th to May 18th, 2021.
However, when the bears dragged the price below the support zone, the zone turned to resistance and has not allowed the price to break through since. This is a case where a support zone has turned into resistance.
Key Points To Consider
When analyzing a currency, traders should look for support and resistance levels as these can represent good entry and exit opportunities.
In an uptrend, traders should look to buy at support levels, and in a downtrend, traders should look to sell at the resistance line.
Support and resistance levels are not final and professional traders will try to look for stop orders. Therefore, traders must hold the stops to avoid being run over by market makers.