Definition
Support & resistance are key price barriers that stop an asset’s price from making overly dramatic moves. Support acts as a floor for the price & resistance acts as a ceiling.
Understanding Support & Resistance levels
Support & resistance are a fundamental part of analysing a cryptocurrency (or any asset) in the short term. They refer to important price levels on a chart that indicate the area at which an asset will:
- Fall to a certain price and then bounce back up as there is a sufficient demand from people wanting to buy at that price, thus preventing the price from dropping any lower (support level).
- Rise to a certain price level and be rejected, causing a reversal into a downwards trend as there are enough people willing to sell the asset at that price. This stops the price from going any higher (resistance level).
SR levels are used by crypto swing & day traders to plan entry/exit points and predict how a crypto asset’s price will move in the near future. These levels prevent overly dramatic declines/surges in price and can occasionally cause a short or long term reversal of the initial trend in the other direction.
EXAMPLE
Jake is a day trader watching the BTC 1hr chart. The price is slowly descending and approaching a key support level of $30,000, where it has touched, or ‘retested’, and bounced up from several times before (indicating that plenty of buyers will buy BTC at $30,000).
Just before reaching $30,000 and potentially going even lower, Jake sees the price begin to reverse and begin moving back upwards. He waits a few minutes and then takes this as confirmation that the support level has held (meaning the price will probably not descend lower than $30,000 in the short term) and he buys in (along with many others) at just above the $30,000 mark, sending the price back up.
Jake may also want to place an automatic sell order (stop-loss) for his BTC just below the support level of $30,000 as if his prediction is wrong and the price does fall through the support of $30,000, it could be seen as a negative sign or ‘bearish’ development, indicating that there is no more demand to buy BTC at that price (meaning the price may keep falling until a new (slightly lower) support level is established). In this case he would be wise to sell and cut his losses as early as possible, hence the stop-loss order.
What determines Support & Resistance levels?
Although SR levels are a key to technical analysis, they don’t necessarily correlate with any technical pattern but exist because of how the human mind tries to make sense of the world. Support & resistance are formed by:
- Human psychology & emotion
- Historical price action/past trend patterns
- Market sentiment (if attitudes are bullish (positive) or bearish (negative))
- The point at which people feel an asset is overvalued/undervalued
- Anchoring (memorable key buy/sell prices used as reference points)
- Levels at which institutions & big buyers want to buy/sell an asset
How can you find support/resistance levels?
Generally, support forms around the previous price lows, while resistance forms around the previous price highs, so the simplest way is to look at an asset’s price chart and analyse the recent highs/lows in a certain time period.
Keep an eye out for levels & areas where the price has touched, retested and seen a trend reversal. The more times a price level acts as a barrier for a price trend, the more key/established the SR level. There are also a variety of more advanced technical indicators that can help you find SR levels (moving averages, trendlines, Relative Strength Index (RSI), etc.) if you want to confirm SR areas with multiple strategies.
Key characteristics of Support & Resistance levels
Support/resistance levels are not fixed and can often ‘flip’
Generally, a broken area of support will turn into an area of resistance when broken (and vice versa), resulting in a support-resistance flip.
SR levels ‘absorb’ buy/sell pressure & will eventually be worn down
When the price retests an SR level and is ‘rejected’ (the trendline sees a reversal), some of the buy/sell pressure from the market is absorbed. When enough buy/sell pressure/orders at this SR level have been absorbed/exhausted, the SR level will be broken. The more times the price retests a support/resistance area (and the greater amount of time in between retests), the more likely it is to break the level.
Support & resistance are areas, not exact levels
SR level are not always met at the exact levels of prior lows and highs, but rather in their general vicinity. This is because buy/sell orders are generally placed either slightly above or below the levels as many traders expect a reversal at a certain price level so they ‘frontrun’ the level to make sure their order gets filled.
Breaking support levels is ‘bearish’ & breaking resistance is ‘bullish’
When price breaks through a key support area it is regarded as bearish development, which means the price will likely drop further until sellers stop selling & buyers start buying again, creating a new (but slightly lower) level of support. Similarly, breaking through resistance is a bullish (positive) sign as prices tend to keep rising with the previous ceiling broken until sellers sell/take profit, creating the next (slightly higher) resistance level.
Key Takeaways
- Support & resistance levels can be thought of as (temporary) floors & ceilings for the prices in any financial market.
- Basically, an area of ‘support’ is where the price of an asset tends to stop falling, & an area of ‘resistance’ is where the price tends to stop rising.
- Traders use SR levels to plan their entry/exit points & find the ideal price at which to buy/sell an asset.
- The ability to consistently identify support/resistance zones can bring many favorable trading opportunities, also acting as an invaluable risk management tool.
- SR levels are based primarily on buy/sell pressure, past highs/lows, market/human psychology & emotion, anchoring & other technical factors.
- Support/resistance are not exact levels & are actually closer to general areas that may be retested multiple times before giving way.
- After being broken, support & resistance levels can flip – a resistance level becomes a new support (and vice versa) as the price breaks the level & continues in an upwards or downwards trend.
What are the two things that can happen when the price reaches a support/resistance level?
Two things can happen once the price reaches a support or resistance level:
- It can either bounce away from the area (bouncing up from a support level or back down from a resistance level), creating a pullback/reversal
- Or it can break through the SR level and continue in the direction of the trend towards the next support or resistance level.
What factors influence Support & Resistance levels?
- Human emotion & market psychology.
- Traders remember certain key buy/sell price points from the past (anchoring), reacting to them based on both technical & historical factors as well as what they remember or ‘feel’ an asset will do when it reaches a price point.
- If an asset trades around a certain price for a long time, that price is likely to be cemented in the minds of traders. As more people set buy/sell orders near that price point, the more support/resistance levels become established.
- When an asset reliably bounces up off a support level, some of the demand/buying pressure could be from institutions, banks & whales (big holders) who have placed large orders to buy at that price.
What are the three types of participants in a financial market?
To properly understand how a financial market works, you should know that there are three main types of participants that affect the price of an asset.
- Those who go ‘long’, waiting for the price to rise
- Those who go ‘short’, hoping the price will fall
- Those who have not yet decided and are waiting on the sidelines
What is ‘buy/sell pressure’ & how do they dictate support levels?
It can take a little while to get your head around how market psychology and individual traders influence SR levels and price action in predictable ways. Understanding how ‘buying/selling pressure’ relates to SR levels can be a big help.
Put simply, a support level is formed by buying pressure, which is the price at which a large number of traders feel they’d be happy buying an asset at (because they think they’ll be able to sell it at a higher price in the future).
Buying pressure (in the form of buy orders) pile up around a certain price point, creating a ‘floor’ of support because the demand to buy at that price outweighs the people selling at that price, causing the price to bounce off that level. This prevents steep declines and can sometimes shift things back in a positive, bullish direction.
A resistance level is the opposite of this, but it works in the same way. This is the price level where enough traders feel an asset is overvalued and willing to sell and take profit at that point. The large number of people placing sell orders at this price creates a ceiling which can reject the upwards push, often sending the price back down temporarily.
What is anchoring in support/resistance levels?
Anchoring is a term from behavioural finance that describes an irrational bias towards an arbitrary benchmark figure (the anchor). It is a conditioned response by traders that involves the subconscious use of irrelevant information, such as past purchase/sell prices of a crypto as fixed reference points for making subsequent decisions about that asset. This reference point is also known as an anchor.
If, for example, a resistance or support level has been established over a long period of time, it establishes a shared anchor in the minds of many traders who have noticed that particular price point or have bought/sold at that price point. This creates a snowball effect as more traders associate this as a good point to buy/sell, meaning these same levels will likely be resistance or support in the future.
What happens when support & resistance levels are broken?
Support/resistance barriers break once either the buying or selling efforts have been completely ‘absorbed’ by the market and there is sufficient buy/sell pressure to break through the barrier. Occasionally, when these barriers are broken, a major shift in sentiment can take place, resulting in a big price pump/drop and new support/resistance levels being established.
Usually after a few retests (the price touching a SR level), the selling behind an established resistance level will be absorbed and fully exhausted, meaning traders no longer see it as a good place to take profit/sell, but rather as a good entry point for buyers due to the disappearance of the previous resistance level. This can result in bullish sentiment and the potential for a big jump in price.
Similarly, when the buying pressure behind a support level runs out and is fully absorbed by the market, the price will drop through it, turning that support level into a resistance level because traders are no longer interested in buying at the previous support price. The breaking of a support level often sees an asset fall further in price until buyers come in and establish a new support level, temporarily reversing the downwards trend and sending the price back up.
What is a reversal?
A reversal is when the direction of a price trend has changed, from going up to going down, or vice-versa. Reversals usually refer to changes in the overall/long term price trend rather than the trend of just a few hours or days. However, there will be many minor reversals (commonly known as pullbacks, retracements or consolidations) within a broader upwards/downwards time as the price oscillates between various support/resistance levels.
What is the difference between pullbacks and reversals?
A pullback refers to a price changing direction in the short term during an overall upwards or downwards trend. A reversal is used to describe a new longer-term trend of price movement. Although they are indistinguishable from one another when they occur, having an understanding of other technical factors and waiting to see what happens is the best way to see whether you are seeing a pullback or a reversal.
A pullback is very similar to retracement or consolidation, and the terms are sometimes used interchangeably. It is a temporary reversal in price that does not change the overall, longer-term trend. These small counter moves provide ideal points to get into a trade if the overall trend is clearly bullish/bearish but you have just seen a pullback, retracement or consolidation.
What is a consolidation?
Retracement and pullbacks are fairly similar but consolidations are a little different. Consolidation refers to an asset oscillating between SR levels and is often interpreted as market indecisiveness, keeping a cryptocurrency’s price within a fairly defined trading pattern. Consolidations are sideways price action that can be broken, for example, by a big piece of bullish/bearish news or a new update that changes how people feel about the asset enough for it to break out of its defined SR zones.
Why are support/resistance levels key for risk management & maximising profits?
The ability to consistently identify SR areas can present many favourable trading opportunities, while also minimising your risk. If there is a major support level that has been key in the past, you may, for example, want to set a sell/take profit order just below that support level. There is a good chance that support will hold as it has done in the past, but if it does give way, there is a good chance the price will keep dropping (at least in the short term), so it might be in your best interest to get out while you can. You can always buy back in at a lower price anyway.
Getting into a trade or going long at the lowest possible price right before it reverses in an upwards direction is ideal in the same way that selling or going short on a trade right before it hits a resistance level will maximise your profits on a trade.
How can you ‘undershoot’ or ‘overshoot’ a support/resistance level?
Support and Resistance are often drawn as lines or levels, but they are actually just areas. Treating them simply as a line and an exact price level can lead you to undershoot and miss a trade, or overshoot and fall prey to a false breakout.
For example, undershooting is when you are watching an asset’s price descend towards a support level of, let’s say, $1000. You have placed a buy order exactly at that support level (as you expect the support to hold and the price to rebound upwards). However, as the price nears your target buy price it suddenly reverses right before getting there and your order does not get filled.
This occurs because a lot of traders expected the support to hold and reverse the trend in the short term, so they were ‘frontrunning’ the exact support levels by putting their buy price a bit above the actual target support price. While this means buying in at a slightly higher price than the expected bottom, it increases the chance that your order will actually get filled and your trade executed, which is crucial, especially if you are automating your trades and are not at your computer.
Overshooting is a similar concept that occurs when the price of an asset rises and breaks through your resistance level, and you assume it’s broken. You buy in, thinking that the trend looks bullish only to see the trend suddenly reverse and head back down. This is called a false breakout (and potentially a ‘bull trap’ – explained later on) and can be avoided by waiting for stronger confirmation of an upwards trend before buying in.
What is ‘waiting for confirmation’?
A trader may ‘probe’ or ‘wait for confirmation’ as a price approaches an SR line. As markets can be volatile and unpredictable, you may want to wait to see if the price does succeed in convincingly breaking through a support/resistance level before you enter a position. While this means you might not get in as low as others who are a little more trigger happy, you are less likely to deal with the instant regret of falling pretty to a false breakout.
What is a false breakout?
A breakout is when a price pushes through a support or resistance level aggressively (with a lot of trading volume behind it) and continues upwards. However, the price can often break through a support/resistance level, only to reverse back shortly after, causing a ‘false breakout’.
Example: SR levels are not exact numbers – they are areas. For instance, if you are watching a chart and think that the resistance has been broken, other traders might think otherwise, seeing it as a good opportunity to short the asset and bet on its price falling.
This could be due to enough traders feeling that asset is not ready to go above its current price point, so they will look to short the asset at the highest possible price they can get (which maximises their profit if they are hoping for as sharp a crash as possible). What results from this is the asset potentially breaking out above your resistance level for just a moment, only to be met by a whole bunch of people shorting the asset, sending it back down again. This is called a false breakout or a ‘fakeout’.
What is a ‘bull trap’?
A bull trap is when a small number/low volume of traders conspire to buy an asset in large quantities, causing the price to be pushed up in a short period of time. Many traders would see this and think it is the start of an extremely bullish run, joining the party and buying some for themselves.
Once there is some momentum pushing the price up to a satisfactorily high level, the handful of traders who initially bought in large quantities sell the asset all at once, locking in their profits and sending the price back down, taking plenty of investor’s money with it.
How does trading volume interact with support/resistance levels?
Trading volume plays an important part in understanding the conviction & substance behind a price move (whether or not it is likely to continue in the direction of the trend). High trading volume indicates there is some backing behind a price move (more traders are making the same decision to buy or sell at the same time). Low trading volume means it may just be a temporary price surge/drop that has little backing behind it.
If a cryptocurrency’s price is experiencing a prolonged downtrend, then all of a sudden it does a 25% increase, the trading volume can give you some much needed info on this move. If trading volume is high this could be an indicator that the downward trend is reversing and things might be heading back up. However, if the trading volume is low, this could suggest a temporary rise (or a bull trap!) rather than a complete reversal of the bearish trend.
Why is it good to submit two pending exit orders whenever you enter a position/make a trade?
When entering a new position, it can be advisable to simultaneously submit two pending exit orders: A stop-loss & a take-profit order. SR areas do more than just give you the best entry point for a trade. They are also useful risk management tools, effectively suggesting where your take profit/stop loss orders should be set.
Example: Imagine you have just bought and entered a long position just above a support area. You are confident the trend is bullish but you want to have a contingency plan (an invalidation point) in case you were wrong. Thus, it is prudent to set a stop sell order just below the support line, in case the trend goes unexpectedly bearish and plummets. And if you are right, maybe you also want to set a take profit/sell order just below the next upper resistance line so you can lock in some profits while you are up!
What is an invalidation point?
Every trade you place should have an invalidation point, which is basically where you acknowledge that your initial prediction was wrong and that you start thinking about getting out and cutting your losses so you can live to trade another day. Practically speaking, an invalidation point is where we place our stop-loss order.
In the world of trading, losses are inevitable. The important part is that you lose small and win big. Some of the most successful traders lose far more times than they win but still manage to make a glorious profit. And what do they all have in common? A risk management system and a trading strategy that they stick to.
Invalidation points are different for everyone and can be based on:
- The specific trade, your trading strategy & your risk tolerance
- Technical factors (SR levels, moving averages, etc.)
- News & developments in the space
- Market sentiment
- The certainty with which you made the trade
What is a reversal?
A reversal is when the direction of a price trend has changed, from going up to going down, or vice-versa. Reversals usually refer to changes in the overall/long term price trend rather than the trend of just a few hours or days. However, there will be many minor reversals (commonly known as pullbacks, retracements or consolidations) within a broader upwards/downwards time as the price oscillates between various support/resistance levels.
What is a reversal?
A reversal is when the direction of a price trend has changed, from going up to going down, or vice-versa. Reversals usually refer to changes in the overall/long term price trend rather than the trend of just a few hours or days. However, there will be many minor reversals (commonly known as pullbacks, retracements or consolidations) within a broader upwards/downwards time as the price oscillates between various support/resistance levels.
What is a reversal?
A reversal is when the direction of a price trend has changed, from going up to going down, or vice-versa. Reversals usually refer to changes in the overall/long term price trend rather than the trend of just a few hours or days. However, there will be many minor reversals (commonly known as pullbacks, retracements or consolidations) within a broader upwards/downwards time as the price oscillates between various support/resistance levels.
