What Is Support and Resistance in Trading?

A resistance level is an area where rising prices are likely to slow down, at least temporarily. The basis to believe in this is that, several times in the past, bullish price runs for the security indeed ran out of steam at this level. “But” you might ask, “why should that convince me the same is due to occur now? After all, there were also times when the asset’s prices surged right through that barrier! Furthermore, what was it that halted prices on past occasions if not traders’ beliefs that buying pressure would ease at this level? If so, the only real forces ensuring prices respect this boundary line are traders’ expectations. Why, then, should I take resistance levels into account at all?”

There’s a single answer to these questions. Thousands of traders all over the world are aware of price levels for their security where bullish surges petered out in the past. When prices near those levels, traders presume they will, at the least, act as a barrier against an extended bull run. As a result, those traders adjust their behaviour accordingly: either closing off long position or opening short positions on the security. This ensures the “prophecy” from the past will, to some extent, come true. The contrarian attitude traders adopt to the bull run at this level will, in fact, work to slow down prices. In other words: just the fact that so many people respect resistance zones lends them a very real power.

The same is true of support zones, which are areas where dropping prices have tended to find relief on past occasions. All those thousands of traders know clearly that, once prices for this security touch this particular low point, buying interest is bound to be sparked and falling prices will, at the minimum, find a place to rest their feet. Many of those traders will feel bullish enough to open buy positions at this level. Others will close off or reduce their short positions. Overall, traders’ reverence for the support level will make it significant. This is why it’s vital to gain an understanding, firstly, of how support and resistance levels actually work in guiding price trends and, secondly, of the role they should play within your trading strategy.

Key Price Levels

As we have mentioned, a central foundation of support and resistance zones is the fact that they are universally acknowledged. From this perspective, it could equally be true that the monthly appearance of the full moon is considered a hindrance to rising tech share prices – if only it was generally accepted in trading circles that tech shares are held back by full moons. The integral connection between traders’ beliefs and the actual power of certain price levels is evident elsewhere too.

You may hear on the news that your security’s prices are nearing a 52-week high. This is understood to imply that, in the event prices break through that peak, they are likely to keep on surging to unchartered levels. The basis for this reasoning is the same as what we have seen above. Since, in people’s minds, the 52-week high point for a security signifies a price ceiling, it will be taken as a buy signal by a large portion of traders when that point is breached. In their view, prices have now broken through the limitations of that ceiling and this perception, funnily enough, actually gives prices the power to do so. Thus, it’s often the case that a 52-week low or high functions, respectively, as a support or resistance indicator in financial trading. The same is often true of round numbers like the $50 or $300 level for share prices, and also of fresh market highs. In each of these cases, the given price level acts as a sort of trigger for collective bullishness without adding any substantial basis for optimism on its own.

In the cases when traders are expecting falling prices to find support at a particular level, and perhaps getting ready to close their short positions, it often happens that prices bust right through that floor and keep on dropping. This won’t necessarily detract from the importance of that support level the next time around, but it will cause some readjustments to be made. For one thing, traders will recall the next significant support level and watch for a slowdown when prices get near it. For another, traders will now view the failed support level as a new resistance level. Thus, when prices start to rise again, they could run into a roadblock at the former point of support.

In the chart below, you can see that prices for a security have met up with resistance at the $42.50 level three times in approximately four months. A resistance level gains more validity in traders’ eyes if it has halted bull runs on a greater number of occasions, particularly if those times are recent. Therefore, this price level is very likely to come up on traders’ radar the next time prices attempt to surge. You also see, down below, that prices have lately tended to find support at the level of $33.

Trading Off Support and Resistance Levels

Technical analysts spend time looking at a security’s past behaviour at support and resistance levels. Their aim is to figure out the relative influence of these levels on price action in comparison with the other factors that move prices. A resistance level may have halted prices sharply on some other occasion, but perhaps that was because of the additional effect of a damning news report on the company concerned. The same level may have emerged to prominence on a second occasion too, but perhaps today’s economic climate is unusually buoyant and has the energy needed to propel prices above and beyond.

Thus, to those who ask the question, “What is support and resistance in trading?”, the answer is that they are a very useful tool in identifying entry and exit points. These levels don’t have what it takes to do the job all on their own. Traders tend to bear in mind the bigger picture of a security’s price trends when planning their deals, and support/resistance levels are only one part of that picture. Other technical analysis tools are utilized in order to confirm the relevance of a particular level. Some of the most helpful of these are volume indicators, moving averages, and candlestick patterns. When one or more of these indicators (with a special emphasis on volume indicators) confirm that prices look likely to stall at these levels, it becomes more feasible to act on them. Taking the case of a resistance level that was successfully confirmed, a trader might choose to open a short position once it is reached, but ideally he would wait to see that prices indeed stalled at that point.

There are other things to look at, however, beyond the field of technical analysis when you are planning your deals. What did the latest earnings report for your company say, and how was it received? Has your company been featured in the mainstream media lately? Have there been strong pockets of negative opinion forming about it on social media platforms? Remember that these online communities have the power to magnify positive or negative sentiment about a company quite quickly. Beyond this, what is the macroeconomic scenario we find ourselves in at the moment? In answering this, you should refer to things like interest rate projections in the US and eurozone, geopolitical tensions in key areas of the globe, and societal trends like the drive to reduce carbon emissions.

Support and Resistance Levels in Action

Between early January and late March of 2022, Bitcoin became wedged in a trading zone between $35,000 and $45,000. On March 27th, prices finally broke through to $47,583, triggering widespread celebration among Bitcoin bulls. Nexo’s Antoni Trenchev explained why the breakthrough was so significant: “This is another one of these Bitcoin moments when the narrative could swiftly change and investors pile in, propelling Bitcoin prices higher”. Another analyst, Fadi Aboualfa of Copper, agreed that the transcendence of the $45,000 level meant prices were bound to shoot even higher, at least to $52,000 (another resistance level), but possibly even to $65,000.

One month later, however, on the final day of April, one Bitcoin was worth only $37,792.73, down over 20% from its level on March 27th. Bitcoin had been driven groundward by risk-off sentiment in the financial markets that was catalysed by a hawkish Fed policy outlook. Analysts’ grand predictions that Bitcoin prices, having broken the resistance at $45,000, would surge to ever higher levels, fell by the wayside.

And then in May, when Bitcoin continued to plummet, losing another 16% in the course of the month, analysts again tried to invoke support and resistance levels to re-assert their bullish case for Bitcoin. “If it can hold the psychologically important $30,000 level”, suggested Jamie Douglas Coutts of Bloomberg Intelligence”, it could range-trade to resistance at $40,000”.

By the end of June, it was clear that this forecast was not going to materialize. Bitcoin was holding at only $18,916.88, having lost a massive 40% in the course of that month. The coin had been beaten into submission by a general collapse of the crypto market after digital lender Celsius put a freeze on customer withdrawals.

Support Resistance Indicator Conclusion

From the above, we learn some important lessons about support and resistance levels. Analysts’ interpretations of the most relevant or best support and resistance indicator are subjective and, therefore, potentially flawed. Even when experts present convincing and exciting projections of future bullishness, citing as proof the fact that prices have broken through a key resistance zone, the reality is oftentimes more complicated than they suggest. The manifold factors that influence security prices at a given time are genuinely difficult to decipher. We saw an example of strategists over-emphasizing the breakthrough of resistance for Bitcoin at $45,000 in March of 2022.

This is not to say the experts are never correct. It’s only to say that one analyst’s viewpoint is not to be taken as unarguably true. We also learned that sudden news events like the implosion of the Celsius Network have the power to batter down prices irrespective of any support levels analysts may have in mind.

What comes out of this is that support and resistance levels are two of the many colours a trader has available on his palette when attempting to paint a picture of where prices are heading. These levels are most effectively used when applied together, in just the right proportions, with the other colours (indicators) he has at his fingertips. Reading a range of market analysis can be helpful when you’re learning how to integrate support and resistance levels into your strategy. Ultimately, though, it’s up to each individual trader to form a coherent viewpoint on his own.