Detailed Explanation of Support and Resistance

1 year ago
AntBot
19 minutes

Contents:

The definition and reasons for resistance and support

As a futures trader, the law of change in the futures market is the main object of our research. When analyzing the crypto market, we usually start from both technical and fundamental analysis. Here, we are mainly looking at two important factors in the technical analysis: support and resistance.

We all know that the relationship between supply and demand in any commodity market determines the variation and direction of the market. Whether it is a small agricultural market or a large international commodity market, all abide by this basic rule. The emerging crypto market, as part of the financial market, is certainly no exception.

The price oscillates in the support area before the breakout

In order to deeply explore the reasons for the formation of support and resistance, we will analyze the root of the market and the psychological factors of the public.

First of all, let’s define support and resistance from the point of view of supply and demand: support, which is actual or potential buying, the amount of which is enough to temporarily stop the downtrend of the price. Resistance is an actual or potential selling order whose number can satisfy all buying orders at that price and temporarily prevent the price from rising. In fact, the support represents the area of concentration of demand, and the resistance represents the area of concentration of supply. We emphasize the concept of “concentration zones”, because demand and supply are always in balance, and their relative strength or concentration will determine the development of price trends. In charts, support and resistance are expressed in a certain form. We call a valley or “upward bounce lows” on the chart as support, displayed in terms of a certain price level or an area on the chart. Below it, the buyer’s interest is large enough to support the pressure formed by the seller. As a result, here the price stops falling, turns back, and bounces upwards. The resistance is the opposite. Because support and resistance have their manifestations on the chart, this makes the market movement traceable, and we can even analyze the market through these things and predict the law of market patterns to a certain extent.

The psychological analysis of formation support and resistance is as follows: In the complex environment of many market participants, for the sake of brevity, we divide market participants into three types: bulls, bears, and spectators. Bulls are traders who buy. Bears are traders who sell. Spectators are those who have closed their positions out of the market or who are still hesitant between buying and selling. Let’s assume that the market starts to move upwards after certain support has fluctuated for a while. The bulls (those who bought close to the support area) are happy but regret that they didn’t buy more in the first place. How nice it would have been if they had added some more long positions around the U-turn approaching the support area! The bears now finally realize (or suspect) that they are on the wrong side and hope that the price will fall back to the area where they sold so that they can get out at the entry point (the “break-even point”). There are two kinds of spectators, some have never held a position, and some for one reason or another have already sold and closed the long position on the support. The latter group closes out their long positions prematurely and then regrets it, so they expect another opportunity to approach where they sold to cover those long positions. Finally, there are those who hesitate. They have now finally recognized that the price will rise further and are determined to enter the market at the next good time to buy and side with the bulls. All four are now determined to buy in the next round of decline, then this support zone below the market is in everyone’s “interest”. If the price drops near this support, new buying by the above four groups will naturally push the price up. If more frequent trading occurs in this support area, it means that more market participants have a “vested benefit” here, and therefore the more important this support is. In an uptrend, because prices rise, the combined reaction of market participants to each decline is to buy more and therefore have new and rising support. However, the opposite is true in a downtrend.

The price cannot break through the resistance area

In addition, in chart observation, we often find some interesting phenomena, such as the interchange phenomenon of support and resistance. Regarding the exchange of support and resistance, we give the following definition: After the support level (resistance level) is crossed by the market price to a certain extent, it will be transformed into a resistance level (support level). It is important to emphasize here that the roles of the two can be reversed only if the price crosses the support and resistance levels to a sufficient extent. How many are sufficient? There is quite a bit of subjectivity in judging this issue, and some people think that the crossing of 10% is the standard, and the short-term crossing from 3% to 5% is determined. From the psychological perspective, the two can only play an interchangeable role when the market price has been traversed far enough that market participants are convinced that they are wrong. The farther the market price crosses, the more convinced people are of their new understanding. In fact, it is also a psychological reaction like the above example. There are many reasons for the formation of support and resistance, including fundamental, technical, and traders’ psychological reasons, and even these reasons are combined to interact with each other. But one thing is for sure, for their own interests, traders’ psychology and operation in support and resistance are basically the same as the examples given above.

Support breaks down and becomes resistance

Now that we have done a detailed analysis of the definition and manifestation of support and resistance, as well as the root causes of their formation. Next, we need to make a detailed summary of some of the main methods of how to find these supports and resistances.

The support and resistance formed by the golden ratio

The famous mathematician Leonardo Fibonacci discovered the magical Fibonacci Sequence in nature, which laid the foundation of the Wave Principle, and the golden ratio of the sequence is ubiquitous in nature. The golden ratio has an important application in the retracement position of the price wave correction and is also accepted and widely used by most people. In the uptrend or downtrend, especially in the stage of spitting out and absorption, when the price moves in the opposite direction of the trend, it always follows some special proportional relationship. The proportion of these price retracements to the original trend needs to be memorized as follows: 23.6%, 38.2%, 50%, and 61.8%.To a large extent, a 50% drawdown is the final destination of the spit and where the price will reach as the money flows, of course, this is just a tendency. We set the exhalation and absorption between 23.6% – 61.8%. Among them, 50% and 61.8% constitute the strongest support or resistance, followed by 23.6% and 38.2%. It is worth noting that: under normal circumstances, the greater the strength of the rise or fall, the smaller the retracement range, the common retracement amplitude is within 0.382, and in the case of small upward or small strength, the retracement amplitude tends to reach the position of 0.5 or even 0.618. The trend we study should be used as as the segmentation criterion for the golden ratio. 23.6%, 38.2%, 50%, and 61.8% of the original trend are the future support and resistance areas. (illustration below)

Fibonacci levels serve as both support and resistance to the Bitcoin price

Psychological and technical reasons for the formation of support and resistance become the arbitrage of the pulling party’s delivery of goods. Due to the amount of funds and other issues, it cannot be completed quickly but it will take a long time. During this period, the price needs to be maintained within a stable range for arbitrage. At the same time, the traders who absorb do not want the price to go too far without establishing a position. In addition, a large number of traders follow the main players in short-term trading. As a result, support and resistance are formed more firmly.

Pre-intensive trading area

An area of concentration of relative highs or lows. To be clear, these relative highs or lows are concentrated in a narrow area, and if the current price is higher, this area means a support zone, otherwise, it is a resistance area. In particular, the more times this resistance or support works, the stronger its resistance or support effect. When the expected support and resistance come into play, the support and resistance formed by psychological reasons will be more trusted by traders. The more frequently the transactions occur in the support and resistance zone, the longer the stay and the more positions will accumulate in this “balance zone”, which in turn strengthens the force of this support and resistance.

Bollinger Bands

Bollinger Bands, invented by Jhon Bollinger, is a market analysis tool. Bollinger Bands combines various advantages of fundamental analysis and technical analysis, and market participants believe that it is a very operational analysis tool, which is why it is widely used. Bollinger Bands use the standard deviation of statistical principles to obtain its confidence interval, which can randomly adjust their variability more than Envelopes. The range of the upper and lower limits is not fixed and changes with the price. The upper and lower bands and the middle band can play a supporting and resisting role in different environments, and their effectiveness has been verified over time. In a sense, the use of Bollinger Bands has also become an effective trading method.

When the market enters the stage of exporting and absorbing, we can choose the resistance and support provided by the Bollinger Bands to do some reversal trading. It should be noted here that we only choose to use it when the Bollinger Bands is in the horizontal direction. If you are going short at a high level, it would be a great thing if the price hits the upper limit of the Bollinger Bands without touching a new high. If the price reaches a new high and the Bollinger Band, we try to wait for the price to fall before considering it. That is to say, the support and resistance function of the Bollinger Bands can indicate strong resistance or support when the price does not create a new high or low point and the Bollinger Bands are horizontal. But when the price has a new high or low, we try not to think about Bollinger Bands as they are elliptical and develop upwards or downwards.

Special numbers

Also known as habit numbers, they are developed from people’s psychology and habits, which are fixed support and resistance zones in the crypto market. Here we have to mention: 2, 5 and 8. Here we pay attention to the second decimal place, which is commonly referred to as the hundred points. For example, P/USD1.9200-1.9299, 1.9500-1.9599, and 1.9800-1.9899 are GBP/USD in the range of 1.9000-2.0000 three resistance levels.  The market tends to stop rising or falling on customary numbers, and traders like to use some important habitual numbers as price targets and act accordingly, so these numbers often become “psychological” support and resistance levels. According to this common sense, traders can close their positions and realize profits when the market is close to an important habit number.

Important previous highs and lows

Generally, prices tend to encounter resistance or support near major highs or lows. It should be emphasized that the previous high or low point does not mean that the subsequent rise or fall will stop at this point, but resistance or support can be expected to be around this point, that is to say, support and resistance are not a point, but is a region. Some chart analysis traders also give sacred meaning to highs or lows, thus forming some effective trading methods around these highs and lows.

According to Dow Theory, trends continue: an uptrend must have constantly rising highs (resistance) and constantly rising lows (support), and a downtrend must have constantly falling lows (support) and constantly falling highs (resistance). And whether the previous high and low points can be crossed becomes a necessary condition for judging whether the trend can continue. Thus, previous important highs and lows on the chart become important support and resistance. Traders usually adjust their positions in these places, which also become active trading areas and become important.

Support and resistance generated by trend lines and moving averages (including necklines of various patterns)

A valid trend line after verification can often produce good support and resistance. Generally, a certain trend as its trend line shows will usually continue to maintain the same slope after having a certain slope or evolution speed, so it can determine the price limit position in the market adjustment stage. When the price reaches a trend line, such as an uptrend, the trader will take advantage of the fall to buy, so the trend line provides a support boundary below the market price, while the downtrend line can act as resistance to achieve the purpose of selling.

Trend lines act as support and resistance
The moving average becomes the support for the Bitcoin price

The moving average can actually be regarded as a moving trend line, and the principle of resistance and support is similar to that of the trend line. In the trending market, it can play a good supporting and resisting role. In futures trading and crypto speculative trading, the purpose of traders is to buy on dips in an uptrend, and sell by rebounding in a downtrend. The trend line just provides the buying and selling position recognized by the public, and everyone adopts it unanimously. In the same way, effective support and resistance can also be generated near the trend line.

Determination of intraday support and resistance and psychological analysis

In the above, we discussed the formation principles and methods of the support and resistance generated by the range fluctuation or hovering area. It should be noted that due to the amount of funds, a long time period and the inertia of price fluctuations, these supports and resistances are by no means a point or a line, but a very concentrated area, which is very different from the formation of intraday‘s support and resistance.

The support and resistance of the daily line have a lot to do with the psychology of short-term traders, most of which are generated by short-term speculation. Because of its small volatility and relatively close to the current price, we can usually regard it as a line or a point. This intraday support and resistance are usually closely related to the opening and closing prices of the day, as well as the highest and lowest prices. At the same time, these prices also directly affect the psychology and behavior of traders, providing a reliable basis for us to determine support and resistance.

1. Support and resistance formed near the opening and closing prices

The opening price is often the basis of the entire trading market, and it is the first clue to judge and study the market of the day. In terms of time, it is the beginning of the daily market. For most intraday short-term traders, they usually do not leave large positions overnight in order to control risks, but open new positions on a new day after analyzing yesterday’s market and fundamentals. Therefore, the vicinity of the opening price becomes the trading cost area for short-term intraday traders. Whether long or short, or hesitant and potential traders, for the common benefit, when the price reaches its cost zone, four kinds of traders will simultaneously push the price up to the previous trend. Hence, support and resistance are often coming into being near the opening price.

The closing price is the most important price of the day, and it is also the price accepted by traders in mind, which can be used as a representative of the usual market dynamics. In addition, the closing price is the central reference point for many technical analysts. In order to confirm whether the market’s breakthrough of an important chart price level is valid, it must wait until the end of the trading before drawing conclusions. When the price closes, whether it is the liquidation behavior of short-term traders within the day, the position adjustment after analysis and judgment of mid-term traders, or the price continues or reverses, the closing price will also become a cost area for some traders. Once the price reaches the cost range, traders also push the price toward the previous trend for mutual benefit. In crypto trading, due to the

The closing price is the most important price of the day, and it is also the price accepted by traders in mind, which can be used as a representative of the usual market dynamics. In addition, the closing price is the central reference point for many technical analysts. In order to confirm whether the market’s breakthrough of an important chart price level is valid, it must wait until the end of the trading before drawing conclusions. When the price closes, whether it is the liquidation behavior of short-term traders within the day, the position adjustment after analysis and judgment of mid-term traders, or the price continues or reverses, the closing price will also become a cost area for some traders. Once the price reaches the cost range, traders also push the price toward the previous trend for mutual benefit. In crypto trading, due to the continuity of time and the market, the time of closing and opening is linked together. During this time period, whether a trader closes a position, adjusts a position, or opens a new trading position, the neighborhoods of the opening and closing prices will become the cost area of intraday trading, thus providing effective support and resistance.

2. The support and resistance formed by the highest and lowest prices

The highest and lowest prices are two extreme prices in a day, which are usually prices that traders do not approve of in their hearts, nor can they be used as representatives of ordinary prices. However, traders think that these prices are good prices for buying and selling in a day. Once the price reaches these high or low areas, profit-out and new positions opened in the opposite direction will work together to suppress the price, unless the price breaks out of the current price range strongly. Therefore, the highest and lowest prices can offer resultful support and resistance.

3. One-half of the long upper/lower shadow

The support and resistance are produced by the one-third and the top of the long upper/lower shadow. From the analysis of the formation of the candle chart, we can know that the long shadow is generated by the strong suppression of the trend. The shadow price area itself has the meaning of strong pressure or support. Usually, when the price reaches the long shadow again, the upper shadow is an example, on the one hand, some long traders will close all or part of their positions in the pressure zone, and even open new short positions with new traders, on the other hand, the long traders who previously opened positions at the top of the shadow will all be in a loss, and when the price reaches their “break-even” zone again, they will also be able to cover their short positions and get out. All kinds of traders here will push the price down for the common good, thus creating a strong resistance here until a stronger trend pierces this resistance range. In experience, one-half and one-third of the shadow can often play a good role in support or resistance.

4. One-half of the large red/green real body

One-third of the resulting support resistance. The large real body indicates the strength of bears and bulls, which is a manifestation of a strong trend in the intraday market. According to Dow Theory, one-half, one-third, and two-thirds of the retracement of the trend is usually the location where the pullback ends. These points also coincide with the 0.382, 0.5, and 0.618 retracement points of the golden ratio. They are usually used by most analysts for technical analysis, which is why these positions can often be effective support and resistance.

Our analysis of the above four situations is only a simple analysis of intraday support and resistance, and it is also the reason for the high probability of occurrence in the intraday market. The actual situation is much more complicated than these, in addition to these simple support resistance in intraday trading, sometimes there are some larger levels of capital impact, that is the larger cyclical support and resistance in the day. When large-level support and resistance work within the day, there will inevitably be new large-level funds to join the market, thus affecting small-level support and resistance. Small funds inevitably follow the operation of large funds and roll away in the direction of large funds. That is, intraday support and resistance obey the support and resistance of the large period.