Support and resistance
Support and resistance levels are a core part of technical analysis, providing crucial insight into possible future price reversals.
What is support?
Support is a level on a market’s chart that it bounces off when in a bear trend. Say that an asset is falling, but there’s a price that it won’t drop beyond. Each time it hits that price, buyers take over, and the market rises again. This would be a support level.
When an asset drops to a level of support, sellers are unable to drive its price any lower. Buyers might feel that now is the right time to step in, which creates a reversal.
Support levels won’t only appear on bear markets, though. As a bull market zigzags upward, it may hit subsequently higher support levels.
You can spot support areas on charts of any timeframe. They are sometimes referred to as a ‘base’ or a ‘floor’.
What is resistance?
Resistance is an area on a market’s chart that it has trouble breaking through to hit new highs. Resistance is the opposite of support. When an asset hits it, sellers take over and send its price back down again.
Like support, resistance levels can appear when markets are in bear trends as well as bull ones. They are sometimes referred to as an asset’s ‘ceiling’.
You might also hear a market described as ‘rangebound’, which means that its price is stuck between its support and resistance levels.
Why are support and resistance important?
Lots of traders use support and resistance to help them plan when to enter and exit positions.
As a simple example, a support level that has been hit but not breached multiple times could offer a buying opportunity. By opening a long position near the area of support, you can earn a profit if the market bounces again. Or you could open a short trade near a resistance level, to take advantage of any downward price reversal.
When you want to exit a position, identifying the level at which a price reversal is on the cards can help maximise your profit – or minimise your loss.
Of course, support and resistance levels aren’t absolute and can be broken. Often, when a market breaks through an established area of support or resistance, it goes on to make a move towards the next one.
This can lead to another trading strategy – opening a position on a market when it surpasses its support or resistance level and trading the subsequent move.
Remember, though, that nothing is guaranteed on the markets. They can be affected by a variety of factors.
Major vs minor levels
Not all support and resistance levels are equal. Minor levels will temporarily delay rising or falling prices within a larger trend, while major ones could stop and reverse a trend altogether.
The more times a market bounces off a support or resistance level, the stronger it is seen as being. If EUR/USD struggles to rally up past 1.1965, for example – hitting that point but reversing multiple times – then a major resistance level may form.
Often, the mindset of traders helps to reinforce support or resistance levels. After EUR/USD bounces off 1.1965 a few times, a substantial number of traders might decide to place short the market there. This reinforces the level further.
If a market breaks through a major level, then it may go on to make a significant move in that direction. This is known as a breakout.
That’s almost everything, but there is one more thing to note about support and resistance.
Support can become resistance
Often, an area of support on a bear move can morph into resistance if sentiment turns positive. Likewise, previous resistance can become a new area of support.
Take another look at the example above. The minor resistance levels in one move become minor support levels in the next.
When you’re plotting a strategy after a price reversal, this behaviour can be useful. By looking at the previous trend, you can gain insight into what might be ahead.
Test your knowledge
- A Support
- B Resistance
- A In an uptrend
- C Rangebound