If you’re looking to learn a little about technical analysis, there’s no better place to start than with support and resistance!
Support and resistance refer to two commonly occurring price chart patterns. While the concepts are relatively simple, price charts in the real world are usually not as straightforward as we’d like them to be - something worth bearing in mind!
What is Support?
The price of a financial asset will increase and decrease over time, but sometimes when looking at a price chart you may notice that the price tends to drop to a certain level or rough price area, before bouncing off that level to increase again. This price level is known as the “support” - a level at which there is enough demand in the market to stop the price dropping further, usually driving the price the opposite way.
What is Resistance?
Resistance is the opposite of Support - when examining price charts, you may also notice the price reaches a certain level or “zone” before cooling off and dropping lower again. This is known as the resistance level - a price point beyond which investors are unwilling to pay for the financial asset.
Technical analysts argue that there is a higher probability of a price decrease (or increase) when you’re at the resistance (or support) level than there is of a further price increase (or decrease). Successfully leveraging this higher probability could help you be a more profitable trader over the long run by having more profit making trades than loss making ones.
Of course, with both Support and Resistance - the price could break the trend you see and continue decreasing (breaking below the support level) or continue increasing (rising above the resistance level). While that is entirely possible and does often happen, proponents of technical analysis argue that it is still helpful to look at these levels as tools to help guide trading decisions.
After all, buying a financial asset close to its support level could help you earn more profits than buying it close to its resistance level, if the price does end up following the support/resistance pattern that you’ve observed. And in the event that the price does break through a support or resistance level, you can be readily armed with some seemingly logical reasoning on which to close out the trade at a minimal loss.
Why do we see support and resistance levels?
Support, resistance and more broadly the practice of technical analysis has been debated for decades now - all you have to do to find the debate is google something along the lines of “does technical analysis work?”, and you’ll be flooded with arguments both for and against it. That debate will likely rage on for another few decades to come, so in the meantime lets try to understand why it is that we see support and resistance levels.
The market-driven explanation is that financial assets sometimes encounter price points at which they are either seen as too cheap (support) or too expensive (resistance) by the market overall. When the asset is too cheap, investors rush to buy it at that price, driving the price higher. When it is considered too expensive, investors become sceptical of further gains to be had, and decide to take profits, in turn driving the price lower.
There is also a self-fulfilling aspect to support and resistance levels - if everyone is looking at the same price graph and trading according to support and resistance levels, everyone will spot when the price has reached a support level and decide its time to buy the asset, driving prices higher (and the same is true for resistance levels). This kind of herd behaviour can lead to support and resistance levels even if the asset is not fundamentally “too expensive” or “too cheap”.
Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.
Disclaimer: At Evarvest we believe in making investing and investment education more accessible, but we don’t provide investment advice and individual investors should make their own decisions. While we try our best, we cannot ensure the accuracy of the information we provide.
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