Support and resistance are possibly two of the most basic tools in technical analysis (or price chart analysis). In this article we will explain what each one means and we will see some examples.
A (price) support is formed when the price of an asset reaches a certain level and instead of continuing its downtrend, it “bounces” and takes an upward turn.
In the image we can see an example of a support that is represented by a yellow area where the price has reached, but then it has bounced up again instead of continuing down.
A (price) resistance is formed when the price of an asset reaches a certain level and instead of continuing its uptrend, it “bounces” and takes a bearish turn.
In the image we can see an example of a resistance that is represented by a yellow area where the price has reached, but then it has bounced back down instead of continuing up.
Why is this happening?
Support and resistance levels have an important connotation in terms of market psychology and supply and demand. Support and resistance levels are levels at which many traders are willing to buy (in the case of support) or sell (in the case of resistance). When these levels are exceeded, it is considered that the supply and demand with respect to a certain financial instrument has varied.
A universal level of resistance or support that is usually seen in many financial instruments is that of round numbers. Numbers such as 10, 20, 35, 50, 100 and 1000 are usually important support and resistance areas because they have a greater psychological load for traders.
For example, it is common to see many traders in shares buying shares when the price of the share begins to fall towards a round number like $ 50. On the other hand, it is very likely to see traders sell an instrument when its price approaches a maximum around a round number. The buying and selling pressure gives importance to these levels and that pressure is often guided by psychological connotations of the market.
When a support or resistance level is exceeded, its role is considered to be reversed. If the price falls below a support level, that support level should be considered a new resistance level. When the price exceeds a resistance level it is considered that it should be taken into account as support from now on.
This occurs because it is believed that supply and demand have changed and that this change is what has led to the breakdown of support or resistance.
For example, as can be seen in the image, the horizontal line represents a resistance that the price tested on 2 occasions (points 1 and 2). However, this resistance was broken upwards and became a level of support (point 3 and 4).
Many traders who are just starting out do not fully understand this concept and find it very strange that this happens, however, it is something very common in the market and occurs in almost all instruments.
In the following image we can see an example of a currency pair in which we have an initial resistance zone that was later broken and began to behave as a support level.
Support and resistance are very important elements that play a fundamental role in trends since they are often used to identify when a change in trend occurs.
Both support and resistance levels serve to test and confirm trends and should be monitored by all those who employ technical analysis. It is important to emphasize that support and resistance levels do not always mean a trend change or correction, when a level is exceeded, the trend can be considered to have accelerated, for example, when an uptrend breaks resistance upward.
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