What Is Support And Resistance In Crypto
Support and resistance are crucial elements for crypto trading and are often used by crypto traders in the markets. In fact, many trading strategies and trading indicators build upon the concepts of support and resistance.
Whether you are new or have some experience in the crypto markets, understanding support and resistance and correctly using them can help you make better and more informed decisions in the crypto markets. In this step-by-step guide, we explain what support and resistance are, how you can identify them on the crypto price charts, and some helpful tips on how best to take advantage of support and resistance in crypto trading.
What Are Support And Resistance In Crypto
Support is a price level/zone on the price chart where prices hold and stop declining. Similar to price floors, support holds and prevents prices from falling below a certain level. When prices reach support, traders expect prices to stop falling and start rising.
Resistance is a price level/zone on the price chart where prices stop rising. Similar to price ceilings, resistance holds and prevents prices from rising above a certain level. When prices reach resistance, traders expect prices to stop rising and start falling.
But when support or resistance is breached, cryptocurrency prices tend to take off in an explosive manner.
Support Vs Resistance: What’s The Difference
Support is where a downtrend or previous decline can be expected to pause as (buying) demand starts to equal and eventually exceeds (selling) supply. Resistance, on the other hand, takes place after an uptrend or previous rally where prices pause as (selling) supply starts to match and eventually exceeds (buying) demand.
Why Do Support And Resistance Occur
Crypto prices rise and fall due to demand and supply. When demand exceeds supply, prices rise. When supply exceeds demand, prices fall.
Support occurs when (buying) demand exceeds (selling) supply. Up to that point, (selling) supply has overwhelmed (buying) demand which drives prices down. As (buying) demand starts to match and exceed selling supply, prices stop falling. It could be that traders start to see the value of the crypto or the increase in media coverage drives demand for the crypto higher. Regardless of the reasons, the increase in (buying) demand and a slowdown in (selling) supply stop prices from falling further thereby creating a support level.
Resistance occurs when (selling) supply exceeds (buying) demand. Up to that point, (buying) demand overwhelmed (selling) supply. As (selling) supply starts to match and exceed (buying) demand, prices stop rising. This could happen because of a variety of reasons such as buyers selling and taking profits from their long positions. The increase in (selling) supply and a slowdown in (buying) demand stop prices from rising further thereby creating a resistance level.
How To Identify Support And Resistance In Crypto
For support, look for previous price lows. The greater the number of times that prices test and are unable to break below that level/zone, the more likely prices find support there.
Once an area of support has been identified, use a drawing tool from your trading platform to draw a best-fit line across. This will be the support.
For resistance, look for previous price highs. The greater the number of times that prices test and are unable to break above that level/zone, the more likely prices find resistance there.
Once an area of resistance has been identified, use a drawing tool from your trading platform to draw a best-fit line across. This will be the resistance.
While it might require some practice initially to identify support and resistance on the price charts, constant practice will help you get better at identifying these levels over time.
How To Use Support And Resistance In Crypto
At a support, crypto prices are likely to rise. Crypto traders can buy and take a long position at the support and profit from the potential rally. The crypto trader can set a stop loss just below the support as insurance if prices fall instead.
At a resistance, crypto prices are likely to fall. Crypto traders can sell and take a short position at the resistance and profit from the potential decline. The crypto trader can set a stop loss just above the resistance as insurance if prices rise instead.
Support and resistance work until they do not. When prices eventually break beyond those levels/zones, the previous support tends to become resistance and the previous resistance tends to become support.
We can understand this phenomenon by taking a look at the psychology behind the price movements.
Many crypto traders tend to take long positions at support and short positions at resistance. As such, the entry prices for these crypto traders are likely to be concentrated around the support and resistance. When prices break beyond these levels/zones, the positions of the traders will be in the red (loss). The losses continue to mount the further prices move beyond these levels/zones.
So if prices do end up moving back to the support and resistance and to the levels where the crypto traders entered their positions, these traders are likely to want to close their positions to minimize their losses or exit at breakeven.
As such at the previous support, supply (selling) now exceeds demand (buying), creating resistance. At the previous resistance, demand (buying) now exceeds supply (selling), creating support.
In the example above, after Bitcoin prices broke below the support (blue line), it encountered resistance the subsequent two times when it reached that level. The previous support has become resistance.
Support and resistance also allow traders to quickly determine if they are right. If prices respect the support or resistance and reverse upon reaching those levels/zones, traders can profit from the subsequent move. If prices break beyond those levels/zones instead, traders can immediately know that they are wrong and exit their positions for a small loss. This allows traders to potentially profit from a substantial move when they are right and only suffer a small loss when they are wrong. In other words, traders can achieve a favorable risk-to-reward ratio when using support and resistance.
Disclaimer: This material is for information purposes only and does not constitute financial advice. Flipster makes no recommendations or guarantees in respect of any digital asset, product, or service. Trading digital assets and digital asset derivatives comes with significant risk of loss due to its high price volatility, and is not suitable for all investors.