Dolomite Learning Series: Resistance and Support
Technical analysis is a valuable tool that is used to help predict short term price fluctuation. One of the most basic concepts of technical analysis is resistance and support. Support levels are where demand is thought to be strong enough to prevent a price decrease. Resistance levels are where sellers have enough volume to prevent a price increase.
Figure 1 — Resistance and Support — Source: tradingsystemforex.com
Resistance and support are both a result of human psychology. If traders feel that a tradable asset is undervalued they will look to buy. Conversely, traders will tend to sell if they see an asset as overvalued. Trading is a battle between buyers and sellers. Supply is synonymous with bearishness and selling. Demand is synonymous with bullishness and buying. Resistance and support provide a general channel of price action. However, these price levels can be broken if there is sufficient volume and momentum. This is called a “breakdown”. A breakdown is a shift in market psychology resulting in new levels of resistance and support.
Figure 2 — Resistance and Support/Breakout — Source: investtech.com
As you can see in Figure 2, once a resistance is broken it becomes a new support level. The same applies to broken support becoming resistance. When trading it is important to consider that round numbers tend to be key resistance and support levels due to their psychological importance. Buyers will typically buy as price moves down toward a round number (and vice versa). This increased buying and selling action occurs to “defend” key support/resistance levels.
Figure 3 — $6,000 provided a strong level of support for BTC before the downside breakout — Source: Tradingview.com
Understanding basic human behavior and psychology is extremely important when trading. Resistance is a result of the sell-off/profit-taking that occurs when an asset increases in value. Support is a result of the opportunistic buying that occurs when an asset decreases in value.
Resistance and support levels are vital to trend analysis because they allow us to make informed trading decisions and may indicate a trend reversal. However, a break in the resistance or support does not necessarily indicate a change in trend. Traders must be wary of false breakouts. According to Investopedia, a false breakout “occurs when a price moves through an identified level of support or resistance but does not have enough momentum to maintain its direction” (see Figure 4).
Figure 4 — False Breakout — Source: Dailyfx.com
In addition to Resistance and Support, traders utilize various indicators such as Moving Averages, RSI, and Bollinger Bands. I will discuss these indicators in future installments of the Dolomite learning series. Happy Trading!
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Disclaimer: The information here is intended to be used for educational purposes only and is not financial advice. I am not a financial adviser.
