Support, Resistance, and How to Trade Them

What are support and resistance?

Support and resistance are widely regarded as two of the most important technical analysis concepts that a trader can learn and use. This article will dive into the fundamental reasons behind why they exist, and how we can use this knowledge to pinpoint areas on a chart where we might be interested in looking for a signal to enter a trade.

Support in this context can be defined as “an area on the chart of a stock/forex pair/cryptocurrency pair/etc. where the price action struggles to break through to the downside, and ultimately a.) bounces off of and climbs or b.) breaks through falls below.

Resistance in this context can be defined as “an area on the chart of a stock/forex pair/cryptocurrency pair/etc. where the price action struggles to break through to the upside, and ultimately a.) bounces off of and falls or b.) breaks through and climbs.

These areas exist because of an increase in buyer interest (support) or an increase in seller interest (resistance) in certain areas.

For instance, when a bull market stalls at an area of resistance (or makes a new high and starts to pull back), it means that sellers “came in” to the market, overwhelmed the buying pressure, and the overall sentiment of the market “swung” to being more interested in selling at those areas than buying. We know that when there is more selling than buying in a market, people looking to sell will have to accept less and less money for their assets in order to find a buyer, and this is what drives the price of the asset down.

This explanation is exactly the same when price finds in what was a bear market, but the roles are essentially reversed. Buyers “come in” to the market and overwhelm selling pressure, and have to pay higher and higher prices to buy the asset, which drives the price up.

With this understanding of the concepts behind resistance and support, we now know to look for resistance at areas where we believe that sellers will overwhelm buyers, and to look for support at areas where we believe that buyers will overwhelm sellers.

It is important to note that just because we don’t see a reason for price to bounce at an area doesn’t mean it can’t bounce there. In other words, a trader will come to find that most areas where price action finds support or resistance were impossible to predict ahead of time. This has very important consequences for our trading- namely, if a position is open but seems to be bouncing unfavorably off a hidden support or resistance area, and the predetermined target price hasn’t been reached, it may still be beneficial for the trader to take off some or all of their position and secure profit. Price can, at any time, find one of these hidden areas and turn against the trade.

However, there are obvious support and resistance areas that we see ahead of time, so in this article we will focus on some strategies to find them and use them in our trading.

How to Identify Possible areas of Support and Resistance

The first (and most common) method of identifying support and resistance areas is to look at a chart and place lines on the levels where the price action has previous bounced off of.

For instance, if I were to identify a few major areas of support and resistance using horizontal lines on this chart-

 

I would place them like this:

 

 

The red line is a major resistance area where buying pressure was overtaken by selling pressure in the past, and it would be reasonable to expect that if price came to that area, it would bounce down off of it or at least slow down as sellers gain pressure.

The green lines are major support areas where selling pressure was overtaken by buying pressure in the past, and it would be reasonable to expect that if price fell to that area it would be met with increased buying pressure and bounce up off of it or at least slow down as buyers gain pressure.

Support and resistance can also be found at moving averages and bollinger bands on every time frame, and on diagonal trend lines. Bollinger bands and EMA’s are pretty straightforward to use and tend to work fairly well.

 

However, since diagonal trend lines are a prediction based on not only the previous horizontal support or resistance levels

 

 

But also the angle between them, extrapolated into the future

 

 

They tend to be less reflective of the actual behavior of the market, and more useful for projecting where price could be at a given time in the future.

 

In addition to this, a trader attempting to draw diagonal support and resistance lines could pick any two or three swing highs or swing lows on a chart and draw a trendline between them, and the chart would end up looking like this:

This is neither visually appealing nor is it conducive to good trading, but I see people charting like this a lot. Since these are more predictive and their placement is up to the trader’s discretion, there isn’t really a definitive way to draw them, and I personally find myself using them less and less as time goes on.

 

 

Applying Support and Resistance to a Real Trading Scenario

To trade this chart (the ETH/USD Daily chart) I would personally just use an EMA to get a sense of trend direction, strength, and support, and look to enter long for a move up to a resistance area at a previous swing high with a stop loss below support at a previous swing low.

 

If price were to move up to this previous resistance at the swing high, I would close my long position, because it would be reasonable to expect that the price action will bounce off of that area or slow the uptrend.

 

Lastly, it generally isn’t a good idea to just short at resistance and buy support, as these are only possible areas will price will find increased pressure in the opposite direction. However, when paired with an entry signal, in addition to proper risk management, proper support and resistance levels give a trader a good basis on which to build a trading strategy.

Written by, Cole P.
The Crypto Space

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