Has the bear market got you down? It’s not a good feeling to be in the red, but bear markets are a good time to polish up your skills and prepare for the next bull run.
In this series, we will be covering some of the concepts used by traders. With some practice, you’ll be able to make use of these tools to enter and exit the market at the right times.
Support and Resistance
One of the most basic concepts used in trading, it is important for investors and traders to have a basic understanding of how it works.
Consider the bullish graph above. The highest point reached before prices dropped is the resistance. The lowest point reached before the market begins moving upward again is called the support.
These levels are not fixed numbers, nor do they guarantee a reversal in trend. Support and resistance levels should always be used in conjunction with other tools to increase the accuracy.
Moreover, candlestick charts are often used when looking at cryptocurrency. If you have not read the previous article on candlestick charts, do check it out here to get a better understanding.
With candlesticks, there are the ‘wicks’, or ‘shadows’, that show the range of price traded in the day. If resistance and support levels are charted as exact numbers, the wicks will often break through; the wicks are often market reactions, rather than an intentional movement.
There are a couple of ways to avoid misreading the information.
Use Line Charts
Unlike candlestick charts, line charts only show the closing priceof each day, without adding in the highs and lows of the day. This gives a simpler chart, without registering the knee-jerk reactions the market has (unless you’re looking at an extremely short time frame).
Use Support and Resistance ‘Zones’
Plotting these zones is simple: just mark out the areas where peaks or valleys are forming. These zones are indications of the support and resistance levels, and will allow for market reactions. This reduces the chances of a ‘fake-out’, where resistance zones were not broken, merely tested.
How strong is the Support/Resistance level?
The strength of a level is directly related to how many times it is ‘tested’ without breaking. We will be looking at the diagram above for an example of a strong support and resistance zone.
The resistance level has been tested four times, and each time the price bounced down after hitting the zone.
Meanwhile, the support level has been tested six times; each time the price reached the support zone, it began to rise upward.
A trader who is familiar with support and resistance levels would feel comfortable trading within this band, as it is unlikely to break the trend for now.
That being said, it does not mean that a ‘strong’ level cannot be broken.
What happens if a Support/Resistance level breaks?
When a support level breaks, it is an indication that there are no longer buyers who find the entry price attractive. In contrast, a break in the resistance level indicates that the demand has increased, and sellers are able to raise the price to new levels.
When the support level breaks, it tends to become the new resistance level. In the same way, when a resistance level breaks, it will likely become the new support level.
These changes in levels are a form of market correction, and help savvy traders and investors determine the trend of the market.
Support and resistance levels are powerful tools. Used correctly, they are a good way for traders to position their entry and exit prices. However, they are just one of many tools that are used to analyze charts. Stay tuned for more tips on chart reading, and get yourself ready for the end of the bear market.
19 April 2018