One of the most well-known techniques of technical analysis is support and resistance.
What are the support and resistance?
Support and resistance reflect the psychology of market participants. When an asset’s price increases to a certain point, it would be difficult to go further at a certain price. Instead, the trend reverses and enters the sideway market.
This is due to the theory of supply and demand. When the price falls, there is a certain price that the market participants support. This is because the buyers are purchasing an asset at a lower price, and fewer sellers sell the asset. Say, more demand at a lower price and lower supply to sell at a lower price.
What is the support line?
The support line is formed when the price falls to a certain point, the buyers are buying the asset at a lowe price, and the sellers are not selling anymore. Thu,s at the support line level, the price no longer falls below the line or transfers to an uptrend or moves sideways.
What is the resistance line?
The resistance line is when the sellers are selling more than the buyers. This can occur when the market participants determined the price is high and start to take profit. Or else, it could be the buyers who bought at a similar price a long time ago, and when the price comes back, they are selling it to recover the loses. Thus, when an asset’s price increases to the point where the majority of the players determine that the price high enough to take profit or sell-off.
Normally the previous peak tends to be the resistance, and the previous low tends to be supported. Hence, one of the most important characteristics of support and resistance is that it will play the opposite role once it breaks through support or resistance. For example, if the price went above the previous high, the previous high turns to support from resistance, vice versa.
Why are support and resistance important?
By analysing the support and resistance, we can know where the price is estimated to move toward. If the price fails to break through a support or resistance, this can be a signal that a reversal is likely to occur shortly. Plus, the more the frequency of supporting or resisting a certain price, the more its significance. This is due to the recent price movement is likely to reflect the price movement in a short period of time.
It is applicable in all asset classes as this is one of the most fundamental reflections of human psychology within any forms of market. It is a toolset to analyse the supply and demand and the core hypothesis of technical analysis.