Support and resistance are import price levels. Traders use them, to determine buying opportunities, profit targets, and placing stops.
I’m not going to get into how to use support and resistance. I just want you to understand exactly what the levels are, why they happen, and how to identify them.
Here’s a handy reference to get you started:
Supply and Demand
I’m going to keep this as short as possible. But the concept of supply and demand is so important I want to make sure we have a good grasp of the basics first.
Markets move based on the forces of supply and demand. When the demand outweighs the supply the price goes up. This is why I’m always watching the float.
When supply outweighs the demand the price goes down.
It’s as simple as that.
Reference the image above. Support is an area or a line that holds the price up.
The reason the price has trouble dropping below the area of support is that the demand outweighs the supply at that price.
Once again check out the image above. Resistance is an area or line that holds the price down.
The price has trouble breaking through resistance because the supply is greater than the demand.
How Support and Resistance Form
I know I’m beginning to sound like a broken record… It’s supply and demand!
When the price is going up everyone is buying. Until people start taking profits, that means they’re selling. As the buying slows others begin to sell too. Sellers start cashing out with the profit they have.
Buyers who just bought see the price stall and quickly exit for a small loss or breakeven. They are trying to avoid a big downturn.
Short sellers see the buying slow and begin selling…
All of a sudden there are more sellers than buyers and the price begins to fall.
But not everyone sells. Some buyers hold as the price falls. They’re now just praying to get back to even.
We call those buyer bagholders. If the price gets close to that peak where they bought then they will sell and be happy they broke even.
There can be a lot of these sellers. And other traders recognize the previous high. When the price is getting back to the top of that spike everyone who bought below starts taking profits.
The bagholders start selling to get out even and shorts pile on too. All the selling drives the price back down.
And the process repeats over and over again.
The same thing is happening at support. Buyers start buying, short start covering…
Identify Support and Resistance
Reference that image at the top again.
To recognize support or resistance levels just draw a line on the chart. Connect the peaks and dips where you see the price turning around.
One cool thing about support and resistance levels is after they fail they have a tendency to become the other.
Once the price breaks through a resistance level it’s known as a breakout. The broken resistance level often becomes a support level.
When the price falls below support it’s a breakdown. The support often becomes resistance.
When I make my watchlist I will often refer to an old area of resistance as support. It’s not 100% accurate but I use it to help build my case for taking a trade.
Here’s a reference image of a breakout. Notice how the resistance becomes support.
That’s it in a nutshell!
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