Support and Resistance basics.
Support and resistance are fundamental to trade successfully.
Knowing them, you can predict large price moves with an excellent accuracy.
They can come in the form of Price Levels, Trend Lines or Moving Averages.
1) Price Levels
A support is a price level where downtrends usually stop. One is confirmed when the price “bounces” 2-3 times on it.
When the price bounces onto a support, it’s a good time to buy.
The price will keep going up.
When the price goes through a support, it means the support is broken. The price has risks to quickly dip. It’s a sell signal.
A resistance is the same, except it’s the opposite.
When the price bounces underneath a resistance, it’s a good time to sell.
When the price goes through a resistance, it means the resistance is broken. it means there’s an unusual buying pressure. It’s a buy signal.
Did you see that I added price on the y-axis of the last chart?
The support is located at $8000. Round prices are psychological supports/resistances. Traders mainly place their buy and take profit orders at round prices.
Therefore, round prices make excellent support and resistance. A good historical example is the $20 000 resistance that reversed the last bull market. It was a psychological level where most traders secured their profits.
Moreover, because everyone is using support and resistance, they tend to be a self-fulfilling prophecy.
Now, the question is, how do you know whether there’s a breakout or not?
You’ll have trouble knowing if the price effectively went through a resistance/support. A good rule is to only consider close prices.
To only consider close prices, you can use a simple line chart.
What I often do is to draw zones, a bit wider than lines. Therefore, if the price goes through a zone, I know the signal is important. It helps to filter signal over noise, at the expense of reactiveness.
2) Trend Lines
Trend Lines are lines on which price bounces. They can act as support or as resistance.
A trend line is confirmed when the price bounces at least three times on it.
Looking at the same data, here’s one we can easily find.
In this case, the price bounced four times on the line. The fifth time the price touched the trend line, it went through. That’s a breakout.
When the price breaks through a trend line, there’s a risk it will go even lower.
However, if the price bounces on a trend line, it means the trend line is still valid. Prices will go up.
As the trend line is going up, we’re calling it an Uptrend line. It acts as a support.
We can also find Downtrend lines. They’re resistances.
That one also worked. The price bounced on it four times and went through on the fifth time.
When the price goes through a Downtrend line, it’s also a breakout. When a Downtrend line breaks, the price has chances to go up quickly.
However, when the price starts to bounce on a Downtrend line, it means the line is still valid. Therefore, the price will go down again.
In this example, you can notice that two trend lines crossed. One of both must be valid. It’s an interesting situation that’s called a triangle. We’ll see how they work in another blog post. You can subscribe to our newsletter to get it first 😉.
If you can’t find valid trend lines, use a log scale. Log scales primarily work on extended periods. It’s in the bottom right on TradingView.
3) Moving Averages
Moving averages can also work as support and resistance. The most known one is the EMA 50. As with other types of support, a support is confirmed when the price bounces 3 times on it.
When the price goes down to a support moving average, two scenarios can happen:
The price bounces on the moving average. The price will go up, probably to the next resistance. Place a buy order!
The price breaks through the moving average. That’s a breakout. The price will go down even more. Place a sell order!
This is BTC/USD. We can see that the price bounced on the support three times. On the fourth time, the price went through the EMA 50. Immediately, the price dipped to $7000.
A round price that already served as a support 😉.
On the other hand, a moving average can be a resistance.
Here’s the same EMA 50 on the latest bear market.
You already know how resistance work. I won’t detail more what it implies!
We have gone over the three major types of support and resistance.
With this in mind, you’ll be able to frame the market and will start to understand market moves.
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