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What Is Support And Resistance?

What Is Support And Resistance? – A ball hits the floor and bounces. Toss it up, and it’ll drop after hitting the ceiling. Support and resistance are like a floor and a ceiling, with prices sandwiched between them. Understanding support and resistance is essential for understanding price trends. Rating their strength helps you decide whether the trend is likely to punch through or to reverse.

What Is Support?

Support is a price level where buying is strong enough to interrupt or reverse a downtrend. When a downtrend hits support, it bounces like a diver who hits the bottom and pushes away from it. Support is represented on a chart by a horizontal line connecting two or more bottoms (Figure 1).

What Is Resistance?

Resistance is a price level where selling is strong enough to interrupt or reverse an uptrend. When an uptrend hits resistance, it acts like a man who hits his head on a branch while climbing a tree—he stops and may even tumble down. Resistance is represented on a chart by a horizontal line connecting two or more tops.

It is better to draw support and resistance lines across the edges of congestion areas where the bulk of the bars stopped rather than across extreme prices. Those congestion zones show where masses of traders have changed their minds, while the extreme points reflect only panic among the weakest traders.

Minor support or resistance causes trends to pause, while major support or resistance causes them to reverse. Traders buy at support and sell at resistance, making their effectiveness a self-fulfilling prophecy.

Figure 1 Shows Daily Chart Of Bitcoin

Support and Resistance

Draw horizontal lines across the upper and lower edges of congestion areas. The bottom line marks the level of support at which buyers overcome sellers. The upper line identifies resistance, where sellers overpower buyers. Support and resistance areas often switch roles. Note how after a decisive upside breakout in area 1 prices hit resistance

Beware of false breakouts from support and resistance. Amateurs tend to follow breakouts, while professionals tend to fade (trade against) them. At the right edge of the chart NFLX is rallying from support at the level where its previous rally ran into resistance.

How do we identify trends? Not by trendlines. My favorite tools are exponential moving averages that we’ll review in the next section. Trendlines are wildly subjective—they are among the most self-deceptive tools. Trend identification is an area in which computerized analysis is miles ahead of classical charting.

Our memories of previous market turns prompt us to buy and sell at certain levels. Buying and selling by crowds create support and resistance. Support and resistance exist because people have memories.

If traders remember that prices have recently stopped falling and turned up from a certain level, they are likely to buy when prices approach that level again. If traders remember that an uptrend has recently reversed after rising to a certain peak, they tend to sell and go short when prices approach that level again.

Figure 2 Resistance Becomes Support

For example, all major rallies in the stock market from 2021 until 2022 ended whenever the BitCoin rallied into the area between 30000 and 69000. That resistance zone was so strong that traders named it “a graveyard in the sky.” Once the bulls rammed the market through that level, it became a major support area. In recent years, whose chart is shown here (Figure 2). It hit the level of $40,000/oz Three times, dropping after each attempt. After the price of  broke above that level on its fourth attempt, the level of $40,000/oz turned into a massive support level.

Resistance Turns into Support

Notice how gold hit its overhead resistance at the $64,000/oz. level Three times. Usually, reversals occur on the first, second hit. When a market hits the same level for the Three time, it shows that it really wants to go that way. Gold broke above $64,000/oz. on its Three attempt.

Support and resistance exist because masses of traders feel pain and regret. Traders who hold losing positions feel intense pain. Losers are determined to get out as soon as the market gives them another chance. Traders who missed an opportunity to buy or sell short feel regret and also wait for the market to give them a second chance. Feelings of pain and regret are mild in trading ranges when swings are relatively small and losers do not get hurt too badly. Breakouts from those ranges create much more intense pain and regret.

When the market stays flat for a while, traders get used to buying near the lower edge of its range and selling or even shorting near the upper edge. When an uptrend begins, bears who sold short feel a great deal of pain. At the same time bulls feel an intense regret that they didn’t buy more. Both are determined to buy if the market declines to the breakout point and gives them a second chance to cover shorts or to get long. The pain of bears and regret of bulls makes them eager to buy, creating support during reactions in an uptrend.

When prices break down from a trading range, bulls who bought are in pain: they feel trapped and wait for a rally to get out even. Bears, on the other hand, regret that they haven’t shorted more: they wait for a rally as a second chance to sell short. Bulls’ pain and bears’ regret create resistance—a ceiling above the market in downtrends. The strength of support and resistance depends on the strength of feelings among masses of traders.

Strength of Support and Resistance

The longer prices stay in a congestion zone, the stronger the emotional commitment of bulls and bears to that area. A congestion area hit by several trends is like a battlefield with craters from explosions: its defenders have plenty of cover and are likely to slow down any attacking force. When prices approach that zone from above, it serves as support. When prices rally into it from below, it acts as resistance. A congestion area can reverse those roles, serving as either support or resistance.

The strength of those zones depends on three factors: their length, height, and the volume of trading that has taken place in them. You can visualize these factors as the length, the width, and the depth of a congestion zone.

The longer a support or resistance area—its length of time or the number of hits it took— the stronger it is.

Support and resistance, like good wine, become better with age. A 2-week trading range provides only minimal support or resistance, a 2-month range gives people time to become used to it and creates intermediate support or resistance, while a 2-year range becomes accepted as a standard of value and offers major support or resistance.

As support and resistance levels grow very old, they gradually become weaker. Losers keep washing out of the markets, replaced by newcomers who don’t have thesame emotional commitment to very old price levels. People who lost money only recently remember full well what happened to them. They are probably still in the market, feeling pain and regret, trying to get even. People who made bad decisions several years ago may well be out of that market, and their memories matter less.

The strength of support and resistance increases each time that area is hit. When traders see that prices have reversed at a certain level, they tend to bet on a reversal the next time prices reach that level.

The taller the support and resistance zone, the stronger it is. A tall congestion zone is like a tall fence around a property. If a congestion zone’s height equals one percent of current market value, it provides only minor support or resistance. If it’s three percent tall, it provides intermediate support or resistance, and a congestion zone that’s seven percent tall or higher can grind down a major trend.

The greater the volume of trading in a support and resistance zone, the stronger it is. High volume shows active involvement by traders—a sign of strong emotional commitment. Low volume shows that traders have little interest in transacting at that level—a sign of weak support or resistance.

You can measure the strength of support and resistance in dollars if you multiply the number of days a stock spent in its congestion zone by its average daily volume and price. Of course, when making such comparisons, we should measure support and resistance zones for the same stock. You can’t compare apples with oranges or AAPL with some $10 stock that trades a million shares on a good day.

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