Traders use price charts to understand an asset’s value and trading volume over time. They also, however, monitor fluctuations in price to establish trends. One of the ways they do this is by keeping a close eye on two key levels – support and resistance.
This article at a glance:
- Support refers to the level at which prices stop falling, and bounce back.
- Resistance refers to the level at which prices stop increasing, and fall back down.
- The level of support or resistance is determined by supply and demand.
Support and resistance: what do they mean?
Support and resistance levels are the floor and ceiling of an asset’s price.
Over a given time frame, you may find that the price of an asset keeps dropping, but only to a certain limit. Similarly, when prices are in an uptrend, you may discover that they never go beyond a certain level within that time frame. These levels form the support and resistance for that asset in the duration of the selected time frame.
The trading support line forms when the asset’s price stops dropping and bounces back. This doesn’t mean that the price is now on an uptrend, but simply that the price refuses to fall beyond this level.
Think of the support line as the floor and the price line as a rubber ball bouncing off it. This dynamic can happen multiple times, over several hours, days or weeks, until a breakout occurs. You can map the support line over a period of time by plotting and connecting points at which prices bounce upwards.
Resistance lines represent the points at which an asset's price stops rising, and finds a ceiling. The price will rise to the support line, but will not cross it until a breakout occurs.
This can happen multiple times, imitating the same bouncing effect as the support line. And just like the support line, resistance lines can be drawn by connecting points at which prices refuse to move up over time.
Why do support and resistance lines occur?
The level of support and resistance is determined by supply and demand. If more people are buying than selling assets, prices begin to increase. At some point, when the prices become unreasonable for buyers, they stop buying and the demand decreases. This pushes prices down.
Similarly, more sellers than buyers indicates lower prices. However, lower prices also mean increased buyer interest, which is why prices may refuse to fall beyond the support level.
So, these levels are markers of buying and selling activity. They represent how active buyers and sellers are compared to each other. However, support and resistance levels are variable indicators, meaning that they can change.
Buying or selling pressure can cause prices to break out of support and resistance levels. They may move into an uptrend or a downtrend, and new support and resistance levels are formed.
Finding support and resistance levels
In general, it’s possible to spot a trading support line by plotting points where the asset’s price refuses to drop. That’s the simple explanation. Now, let’s get a bit more technical. Here are the three main ways you can spot a trading support line:
Historical price data
One way to determine support levels is to look at previous prices and price patterns. When an asset has established notable support and resistance levels in the past, these can be useful indicators.
For example, if a support line has occurred multiple times over a few months, any future trends around this level could be significant. The same applies for resistance levels – if a past resistance level was holding and the price breaks above it, that level turns into a support level.
This is a fairly straightforward way to establish support levels, but context matters. Historical price data doesn’t tell you the setting in which the market was moving at the time. While it’s a useful way to see what previous support levels were, market conditions may have been different to what they are now, which can affect the reliability of historical data.
You can plot trend lines (which are a technical indicator) on a price chart to check for price patterns. These patterns don’t provide a definite answer, but can give you an insight into current price movements and potential breakouts.
Best indicators for support and resistance
Here are some indicators few to watch out for when considering support and resistance levels:
Previous support and resistance levels: Using previous support and resistance points can be a simple way to establish support and resistance levels. If the current trend matches existing support and resistance, it could be that prices continue to trade within this range.
Moving averages: Enable the moving averages indicator on your trading platform. Draw a line from the highest peak to the lowest one in your time frame of choice. If the trendline moves upwards, the moving average becomes the support level. If the trendline moves downwards, the moving average becomes the resistance level.
Peaks and troughs: Select a time frame and mark the price high and low can help you identify peaks and troughs. If the trend is bearish, the support level will be lower than the low point. If the trend is bullish, the support level will be higher than the low peak.
Trend lines: Draw trend lines on a price chart. If there are at least three peaks in a certain direction, you can assume that a new trend is forming.
How accurately can you identify support and resistance levels? Test your knowledge by accessing price charts through a live or demo INFINOX account. You can also learn more about support and resistance by following our expert chart analysis.
This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.