Support and Resistance: The Basics of Technical Analysis

Support and resistance are key technical indicators that represent levels on which prices stop on the chart, confronting buyers and sellers of the asset. Aiming to understand price movements, these indicators constitute the foundation of investment strategies in the stock market. But how can you identify these levels? What are their advantages and limitations? How can you trade cryptocurrencies effectively using these technical indicators? The answers await you in this article.

Supports and resistance in trading: what is it?

Support and resistance (S&R) are the pillars of technical analysis and stock market investment. While the choice of other strategies depends on each trader’s preferences, these two indicators remain mandatory in trading. They indicate psychological zones where buyers and sellers face off.

The support is a level where the price of an asset tends to bounce. This level prevents the price of the asset from falling, as buyers outnumber sellers.

The resistance is a level where the price will stall, failing to go higher. This level blocks the rise of the asset’s price, as sellers outnumber buyers.

Thus, these levels are the zones where the price of an asset is most likely to react upwards or downwards.

How to trade Bitcoin with support and resistance?

To trade Bitcoin using S&R, there are three approaches you can adopt:

• The bounce: you may be tempted to place a buy order at the edge of a range; however, S&R levels are not fixed and can easily break. You should wait for a bounce to occur before placing a buy order. A bounce happens when the price of Bitcoin hits a trend line without breaking through it and then moves in the opposite direction.
• The aggressive method: it aims to take advantage of a breakout by entering the trade when the price of BTC surpasses the resistance. This means that sellers have lost this zone, allowing buyers to drive the price up.
• The conservative method: it is used in the case of a pullback, meaning that when the price rises rapidly, it tends to fall quickly and bounce on the old resistance. In this case, it is also wise to wait for a bounce before positioning to buy to reduce risks.

Why are support and resistance important in Bitcoin trading?

S&R are important in Bitcoin trading because they are the pillars of technical analysis.

Advantages

S&R have different advantages for trading:

• Usable in any market: these levels are easy to detect. This makes them flexible for any type of market, whether it be cryptocurrencies, stocks, or Forex;
• Better determine market psychology: market psychology corresponds to the overall sentiment of traders and allows the creation of supports and resistances with round-number prices, for example, $200 or $50,000;
• Ensure better risk management: they help to systematically identify zones that present opportunities and risks;
• Determine an effective trading strategy: S&R zones help better define the stop-loss, for instance.

Disadvantages

However, S&R have some flaws:

• Temporary nature: S&R do not last indefinitely. A support can become invalid at any moment;
• Dependence on the timeframes used: the strength of S&R is heavily dependent on the different time units used;
• Absence of precision: S&R are never completely precise but remain approximate.

How to determine supports and resistances on the chart?

There are different types of S&R that one should know to perform graphical analysis in the stock market.

Recent highs and lows

Recent highs and lows help identify S&R. For example, if the price of Bitcoin drops to $30,000 and rises to $35,000 before dropping again, we can keep an eye on $30,000 as a support zone or $35,000 as a resistance zone.

Indicators

These tools can also be used to determine S&R. There are several, including:

• Moving averages: they allow for analysis of the asset’s evolution, removing transient fluctuations, in order to identify long-term trends. To calculate the moving average, you need to average the different prices from the last few days and then draw a line representing this average. Various types of moving averages include simple moving average (SMA), weighted moving average (WMA), exponential moving average (EMA), and others;
• Ichimoku cloud: represented as a cloud on a chart, this technical indicator provides a quick overview of the market’s general trend. It defines the levels of S&R, gives potential trading signals, and measures the momentum (speed of price movement over a given period);
• The RSI (Relative Strength Index): this is an internal relative strength indicator that indicates whether an asset is overbought or oversold. In a bullish condition, the RSI tends to remain between 40 and 90, with the support zone situated between 40-50. In a bearish condition, the RSI tends to stay between 10 and 60, with the resistance zone situated between 50-60;
• The MACD (Moving Average Convergence Divergence): the divergence and convergence of moving averages allow tracking trends via moving averages to determine the momentum of the cryptocurrency you wish to trade.

Trend lines

Trend lines represent lines on which the price will react. They are connected by specific data points that help traders and chartists to visualize price movements more easily and identify market trends.

A bullish trend line indicates the support levels below which the price is unlikely to fall. A bearish trend line indicates the resistance levels above which the price is unlikely to rise.

Theoretically, any two points on a chart allow for drawing trend lines. However, most chartists believe that using three points or more makes the line valid. The first two points define a potential trend while the third point tests its validity.

How to best use support and resistance?

Knowing S&R is a good thing, but knowing how to use them is even better.

Positioning orders according to supports and resistances

Positioning your orders according to S&R depends on your investment strategy in the stock market, whether it is long, medium, or short-term. However, it is common to place a buy order on a support and a sell order on a resistance.

Indeed, in short-term trading, for example, it is preferable to place a buy when the value of the crypto approaches its support threshold, that is to say, its lower level. Likewise, place a sell when the value is about to reach its resistance level, which is its upper level. When one of these lines is reached several times over a period, the chances of a breakout increase.

Taking into account support and resistance inversions

It is important to note that S&R levels can reverse. A resistance broken from above could become a support, preventing the price from falling back. Conversely, a support broken from below could become a resistance, preventing the price from rising.

The breakout refers to surpassing a trend line. The asset’s price exits a defined support or resistance level with an increase in volume. This generally leads to a significant rise or fall.

Assessing the strength of supports and resistances

Technical analysis is a matter of probability. Therefore, S&R are not 100% correct. However, there are techniques to determine the strength of S&R levels:

• The more often the market has reached a level without surpassing it, the more solid the support or resistance level is deemed;
• The strongest S&R levels are rarely exact numbers;
• The larger the timeframe you are using, the stronger the S&R level will be.

Conclusion

You will understand, it is impossible to perform effective technical analysis or chartism without considering support and resistance. These two elements constitute the foundation of a good analysis of price movements of an asset. If you want to optimize your stock market and crypto trading investment, mastering these two indicators is imperative. However, note that in the face of a very fluctuating market, S&R only indicate simple probabilities.

La Rédaction C.

L'équipe éditoriale de Cointribune unit ses voix pour s’exprimer sur des thématiques propres aux cryptomonnaies, à l'investissement, au métaverse et aux NFT, tout en s’efforçant de répondre au mieux à vos interrogations.