Represents a price level or area where there is more selling pressure than buying pressure and prices cease to advance when they approach this level.
Represents a price level or area where there is more buying pressure than selling pressure and prices cease to declines cease when they approach this level
The Psychology behind Support and Resistance
To understand the psychology behind support and resistance, we need to first categorize market participants. Market participants can typically be classified into 1) the longs -traders who have a long position and stand to profit if prices increase. 2) The shorts -traders who have a position short and stand to profit if prices decrease. 3) Traders who have either gotten out of their previous positions prematurely 4) Traders who are undecided on which side of the market to be on and are looking for entry points either on the short side or the long side.
Assuming now, that prices start advancing from a support area, the longs who bought around this area would have regretted not buying more. So, every time prices come back to the support area, they would likely decide to buy more.
Traders on the short side however, would have likely realized that they are on the wrong side of the market and they would be hoping for prices to come back to the support area where they entered their short positions so that they can get out and at least break even.
The traders who had previously got out of their long positions at the support area would likely be annoyed at themselves for getting out too early and would thus be looking for a chance to get into a position again at or around the support area.
The traders who were previously undecided on which side they wanted to be on would likely decide to want to enter the market on the long side after observing the advance in prices. As such, they would be looking to enter whenever there is a good buying opportunity, which is at or around the support area.
These traders now all have the same resolve to buy should a good opportunity present itself and should prices decline to the support area, there would be buying taking place by all four groups which would result in prices being pushed up.
Why is Price Support and Resistance Important?
In range bound markets, support and resistance define the upper and lower bounds of price movement. In a market like that, traders can consider selling at resistance and buying at support. Traders can watch as price approaches resistance and look for signs that prices would turn back down after hitting that resistance level. The same can be done when prices are reaching a level of support.
In trending markets, support and resistance provide an entry for traders should a trade break through a level of support or resistance.
Identifying Support and Resistance
Support and resistance can be found on charts on multiple time frames and many different forms. Moving averages, trend lines, Fibonacci levels and price channels can all be used to represent support and resistance levels.
To determine horizontal support and resistance levels on your charts, find a level where there is a significant amount of overlapping price action. It is important that with resistance levels, a horizontal resistance line should connect at least three high price points. A horizontal support line should connect at least three low price points.
The longer the support or resistance line holds, the harder it would be for price to break through. Meaning that the more often price tests a level of resistance or support without breaking it, the more significant the area would be.
Every time a resistance level is broken, it tends to change its role and becomes a new level of support. The same concept applies to a level of support.
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