Support and Resistance

Most of the short term traders in any financial market follows some kind of Technical Analysis for stocks, futures, commodities or crypto. It is nothing but a visual understanding of price and volume action. There is another branch of financial analysis called fundamental analysis, which mostly related to stocks and deals with how to properly value a company. We are not going to talk about fundamental analysis today. The popularity of Technical Analysis is simply due to the following facts:

It is simple and visual
It can be applied to any market without any deep knowledge of that market, as long as the market can be plotted on a chart
Most widely traded markets move by 'herd mentality'; and TA does a good job 'predicting' that

Lately a few folks asked me about Support and Resistance, which is a very beginner lesson of TA. There are volumes of free information on the subject over the internet, so I am not going to say anything new about support and resistance. What I can do however, I can share a few interesting personal tit-bits about it and make the understanding a bit entertaining for the new traders. We have quite a few new traders in our community.

First, why support and resistance is important to know for YOU the NEW TRADER?

Market Timing : It helps you where to enter the market and when to exit (the holy grail!)
General 'future' direction of the market!

Wait! Wait! Didn't I always say that 'no one can predict the future'? YES. Absolutely. But that doesn't mean we can't try. We try all the time at all possible scales. That is what trading is all about. Let me explain.

No you can't predict the future for a single instrument at a single instance of time, that is impossible. But I can predict 100 different prediction of BTC/USD at a variety of different scales and different time horizons and can come out correct 60% of the time, using just support and resistance. Do you understand the difference? It means, I can't make a prediction of a single trade (I mean, I can, but I will likely be wrong), but if I make a large number of predictions, I will be statistically correct 60% of the time. Now, you may say 60% is not a high number. Unfortunately you have mistaken. Most successful traders predict correctly just north of 50%, sometimes less; but they can still be successful. Yeah! It's a different topic called "position sizing" which is a part of trading discipline. I will cover that on a later date. Okay, that's enough background... back to definition:

Support is an area on a chart that price has dropped to but struggled to break below. The chart below shows how price drops down to the area of support and subsequently ‘bounces’ sharply from this level.

Resistance is an area on a chart that price has risen to but struggled to break above. The chart below shows how price rises up to the area of resistance and subsequently “bounces” sharply from this level.

Let me explain with a live chart:

Above is a chart of ETH/USD, as traded at Coinbase exchange currently. As of this writing, ETH is trading at $1345.95. Many of the folks I was talking today are trading ETH or interested in trading ETH. So I am using ETH as an example, but it will be indentical for anything else as well. I drawn a single red line at the ATH (all time high), around 1477 (exact number doesn't matter). That is the current resistance, and I have drawn a green line at the low of Jan 21st, that is at 1040. This is at the 15-min scale chart. Obviously more support and resistance lines can be drawn, but at the scale of observation thse two are the extreme ones.

Key thing to understand that there is nothing magical about these prices. It doesn't mean price will rally upto 1477 and promptly drop (but it might, there is a high probability). But if it doesn't drop, that's fine as well, because then we have a phenomenon of breaking of the resistance or simply "break-out". Same thing at the bottom, it can bounce from 1040, but if it collapses through that level, we have a "break-down".

Scale

Support and Resistance can change with the change of the time-scale. Or they may remain same. If they remain same, that is a stronger support or resistance. Let me explain with the same ETH chart, but now at 1-hr scale:

Notice that 1477 ATH resistance, remains here. So is the 1040 support. But I have changed it to a dashed line now. Meaning, at the hourly scale that 1040 support is there, but it is perhaps weaker. Because I am using a single point (low) to draw the support and further back in time, there are no good areas of support there. In stead, I have a new support here at 900. I hope you get the point.

Bonus: Whole numbers can be good support and resistances! like 900 - 1000 - 1100 etc..

Bonus: ATHs are always good resistance (which becomes support as the price goes above it)

Why?

Why support and resistance work? There is nothing magical at those prices. However, when many people who are looking at the chart places buy and sell orders around those support and resistance, it becomes a self-fullfilling prophecy. So that is why they work? We traders force them to work.

Zones

Small variation of the previous chart below:

As I mentioned earlier, support (and/or resistance) doesn't have to be a single line, they are often a zone. In the same hourly chart of ETH, there are several lows in the 1040 to 970 area. That 70 point zone is a good quality support zone.

I hope this is helpful. I will expand this a bit more on a follow up post.

Disclaimer: This is NOT professional advice, this is all just my own opinion and experience. I am NOT a Certified Financial Adviser. Consult professionals for any financial, accounting or legal related questions you have.

Charts are created in Tradingview.com, which is a free service.

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