The fundamental principle of technical analysis comes in the form of support and resistance. When traders are talking about support and resistance they are referring to the two price levels on a chart that prevents the price of assets from getting pushed in a certain direction.
Support level is the level on a chart with potential buying pressure to push the price higher. When there is a concentration of demand, support indicates a price level where the price of the asset can be expected to pause and/or fall during the midst of a downward trend. In this case, demand outpaces supply and the price is going to rise.
Resistance level is the level on a chart with potential selling pressure to push the price lower. When there is a concentration of supply, resistance indicates a price level where the asset can be expected to sell-off in the midst of an upward trend. In this case, supply outpaces demand and the price is going to stop rising or even fall.
A bit more about Support and Resistance levels
Support and resistance should not be interpreted as a single line, rather they represent entire areas on a chart. When a price level breaks through a support or resistance level, a reverse effect takes place. Let me explain. When the price of an instrument breaks below the support level, for example, the previous support level now becomes the new resistance level. Furthermore, when price breaks above the resistance level, the resistance level now becomes the new support level. When support and resistance move alongside the price, we call this dynamic support and resistance with support occurring when there is an uptrend and resistance occurring when there is a downtrend.
Why Are They Important?
These indicators are extremely useful as trading tools to help you identify ideal times to buy or sell particular financial instruments. Most forms of trading are premised on the belief that support and resistance zones will not be broken. Typically, traders can bet on the direction that the price level moves, regardless of whether the price stops at the support/resistance level or proceeds to decrease/increase. When prices move in extreme ways, traders can easily make predictions and determine the way that they want to either enter or exit the market.
How to Implement Support and Resistance in Your Trades
Where Not to Open a Position
You can use the support and resistance tools as a way to place yourself in an advantageous position while trading. Take a look at the diagram pictured below:
When a given asset or instrument is on an upward trend, you want to do your best to avoid buying into a long position when it is nearing the resistance target. This is because you run the chance that the price reaches the resistance and then bounces back, and as a result, severely limiting your profit.
Where Not to Place a Profit Target
You want to make sure that your profit target is not set above the resistance or else you run the risk of the price of the asset or instrument you are purchasing becoming stagnant or bouncing back after it hits the resistance.
Instead, you should be setting the profit target line just below the resistance. That way, you have a realistic method of seeing your profits come to fruition. It is also recommended that you set a stop loss at a point where you hedge the potential of the given asset or instrument to suddenly tank in price.
In summation, support and resistance are very important concepts that one should learn in order to be a successful trader in the markets. The BetterTrader voice assistant will also let you when the market is getting closer to the support levels. Using BetterTrader, you can have them set up automatically for your needs in the markets every day. This includes updated dynamics that represent the latest market conditions all day long in real time. Sign up for free here.