Support and resistance levels are two of the many indicators that are commonly used in trading charts and technical analysis. These levels indicate the points wherein the price movement of the asset can possibly pause temporarily or reverse its prevailing trend. Despite having automated stock trading systems that send timely alerts so you can trade with great efficiency, it’s still important to learn about these support/resistance levels and how they relate to other trading chart indicators.
In essence, a resistance happens when the price of an asset that’s trending upwards is expected to pause due to increasing supply levels or selling interest, and eventually, the price can possibly move on a downtrend. On the other hand, support occurs when a downtrend is expected to pause due to increasing levels of demand or buying interest, and thus, will eventually reverse to an uptrend. Both support and resistance levels are generally caused by market psychology as the financial players take note of the past and react in anticipation of future market price actions.
On a few or rare occasions, there’s too much excitement from bearish or bullish traders to the point that the price movement breaks the barriers of resistance or support. When this happens, new support and/or resistance levels are created. Often, the previous support will become the new resistance for price actions on a downtrend. Similarly, the previous resistance will be the new support for price actions on an uptrend.
To quickly answer the main question in this article: Yes, support and resistance are important when it comes to analyzing trading charts and price movements for many reasons. Understanding these key indicators, which relate to other trading indicators, can help you analyze the market more efficiently as well as help you understand how stock trading systems can further work to your benefit.
They serve as floor or ceiling price
Support levels technically serve most often as the floor price of an asset wherein the downtrend can bounce back as an uptrend once this level is reached. Conversely, resistance levels almost always act as the ceiling price wherein a climbing price action reverses to a downtrend. In essence, support/resistance levels alert traders of potential pause and reversals of price movements, and thus, they can prepare their accounts for crucial and timely trading decisions.
They are potential exit and entry points
A well-identified support/resistance level has generally a strong influence on the direction of the price movement, especially when the price has been unable to move beyond those levels for many times in the past. In short, support/resistance levels are considered stronger the more the price has historically been unable to break through them. It’s for this reason that traders are more confident to take appropriate action at these levels, which eventually increases the volume more than usual and ultimately prevents the price from going lower or higher much further.
They are generally driven by human psychology
Despite the frequent advice to not let emotions interfere with trading decisions, there are still many traders and investors who are emotional. It can’t also be denied that humans can make irrational decisions or commit to shortcuts and heuristics.
When a price action comes close to the support/resistance levels, emotions can rule over the trading decisions of many traders, especially the new, inexperienced and/or casual ones. In fact, resistance and support levels technically will not exist if everyone is completely devoid of emotions when trading.
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They can be identified with trendlines
By now, you’re still probably thinking that support/resistance levels are basically horizontal lines across your trading charts. In reality, market actions most likely form diagonally on the chart and can be conveniently assessed using a trendline. Once you can connect at least three low or three high points of the historical value of an asset in one straight line, you can create your trendlines. Trendlines using low points can indicate the support while those using high points can identify the resistance. It’s best to use one trend line though to avoid confusion.
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They can also be identified with other indicators
Many trading analysts use other technical indicators to identify the support/resistance levels. One example is the Moving Averages, which serves as a support during an uptrend and turns into a resistance during a trend reversal i.e. a downtrend. Another indicator is the Fibonacci retracement level, which creates various support/resistance lines on the chart based on the golden ratio.
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