Most of the simple trading strategies have support and resistance analysis built-in. It is the most powerful pillar in trading. The lines of support and resistance tend to develop in the areas where the prices have approached most times and then rebounded from there. In this article, we shall talk about support and resistance and some top support and trading strategies.
What Is Meant By Support And Resistance?
Support and resistance is a widespread technical analysis technique followed in almost all financial markets. In this procedure, there is a chart that instantly tells the traders about three key areas of interest. These are:
- Timing an entry into the market
- The direction of the market and
- Establishment of points to exit the market. It can be either in profit or loss.
A trader who essentially has a trading idea can answer all the above three items effortlessly. Identification of support and resistance levels on a chart can answer these questions for the trader. However, it is a widely used technique among novice and professional traders. Let us now understand support and resistance individually in detail.
Support is an area on the chart showing that the price has dropped but has struggled to break below. In the theory of support, the price level at which the purchasing power is strong enough to prevent further price declination. The simple concept is that it becomes cheaper as the price becomes close in contact with the support.
Eventually, the purchasers get a better deal and will likely buy the same. But, at the same time, the sellers are less likely to sell as they do not get a better deal. In such a case, the demand rate will surpass the supply rate, and eventually, the price will not fall below the support line.
On the contrary, to support, resistance is an area on the chart which depicts that the price has risen, but it has struggled to break above. Theoretically, the price level at which the selling power is incredibly strong to prevent a further rise in the commodity’s price. The concept behind this is that as the price gets closer to the resistance line, it becomes more and more expensive during the procedure.
However, the sellers are more likely to sell than buyers who are unwilling to purchase. In such a scenario, the supply of sellers overcomes the demand of purchasers, prohibiting the price from rising above the resistance level.
Top Three Support And Resistance Trading Strategies
Mentioned below are the top three trading strategies with support and resistance.
The range trading strategy takes place somewhere between the support and resistance lines as the trader aims at purchasing in support and selling at resistance. For example, let the area between support and resistance be a room. The support is the floor, while the resistance is the ceiling. The range tends to appear sideways of the trading market where there is no clear indication of the trend.
The traders must identify and pick up the trading range while identifying the support and resistance areas. In a range-bound market, traders look for long entries when prices bounce off the support line. On the other hand, when the prices bounce off the resistance line, the traders look for short entries.
Also Read: Why You Should Invest In Bitcoin
Breakout Or Pullback Strategy
It might happen that after a directional uncertainty, the price shall break out and begin to trend. However, the traders commonly look for such breakouts below the support line and above the resistance line for further capitalizing on the increased momentum in one direction only.
If this momentum has the potential, it can begin a new trend. Moreover, in many cases, the traders are extra cautious about not falling into the trap of false trading breakouts. Hence, they wait for pullbacks towards support and resistance before they commit a trade.
The Use Of Moving Averages As Support And Resistance
Moving averages can double up the powerful support and resistance. The famous moving averages include 20 and 50 periods which can be slightly altered to 21 and 55. This is done by making use of Fibonacci numbers. However, incorporation of 100 to 200 moving averages is common for almost all traders. It is upto the trader which setting is comfortable for them.
Generally, 55 moving averages track above the market as a point of resistance. The market then lowers and reverses itself to the emotional level of support. The traders then use these trend lines to make smart trading decisions. Moreover, these decisions are likely to continue the trend and are susceptible to a breakout.
The Final Takeaway
Support and resistance are one of the strongest trading pillars. Almost every trading strategy includes the support and resistance analysis in it. They can either be based on the price respective to the levels like the rage-bound ones or anticipating the breakout point of support and resistance. However, the prices do not respect support and resistance throughout. Hence, the traders must adopt risk management to limit the losses if there is a breakout.