Support And ResistanceWhy Are They Essential?
The most widely used technical analysis tool by professional and beginner traders is definitely that of support / resistance levels. Experts say there is no reliability using oscillator-based indicators andthe only truly effective trading technique is based on the use of support and resistance.
What are they
Support is price level which the downward movement of asecurity has difficulty falling beyondthereby indicating a total or temporary change of a downward (bearish) trend to bullish.
Resistance is defined as the price level which the ascending movement of asecurity has difficulty overcoming, thereby indicating a total or temporary change of an upward (bullish) trend to the bearish.
How do you create them?
In the market the price of an asset is the result of a continuous struggle between buyers and sellers, with buyers pushing prices upwards and sellers down.
In practice, the resistance builds on those price levels that concentrate a large amount of high sell orders to counter buys so as to prevent the Increase.
Conversely, the formation ofsupports takes place on a concentration of buy orders such as to oppose sells and stop the downhill.
These levels are identified by traders as they previously created numerous “rebounds” to make them recognizable. Based on the principle that trading history tends to repeat itself, the more a support/resistance has worked in the past, the more relevant such as level is moving forward.
Effects on the market
Support levels and resistance are very important in terms of market psychology. Traders hope to be able to buy near a support or sell near a resistance, exploiting the "rebound" effect in both cases. When one of these levels is broken, then we can see a breakout situation where the price tends to accelerate no direction of the trend just after the break. In this situation traders tend to sell to the break of a support and to buy after the break of a resistance as rupture can be considered such it is necessary that prices move clearly and decisively beyond the support or resistance threshold.
Almost always, a level of support also acts as a resistance, and vice versa. This is known as change in polarity in charting. The resistance that is exceeded by the rising price becomes a support when the price rises to that level, while a support that is violated by a downward price will become a resistance when the price will go up to that level.
A type of universal support/resistance that tends to work very well is the round digit, i.e. those that ends withfinal zerosafter the decimal point. They work well because they coincide with those psychological thresholds where big traders make decisions.
For example, a quotation of the EUR/USD at 1.20,000 is certainly a very high level of market influence. A level of 1.23000 will also be a good level, butof less influence.Numbers ending at50 or 500, FOR example EUR/USDprice at 1.23500 is also a significant round number level.
The use of supports/resistances depends on traders’ risk appetite and personal trading style.
For a moreprudent approach to trading, a valid advice is to not enter the market at a level of support/resistancewhich is generally characterized by a high degree of volatility. Trades should be placed a little further away, with an expectation that price may exceed the level and finally a confirmation that the reversalhas begun (in the case of countertrend technique) or the break has begun (in the case of a breakout technique).
Those who want to make risky trading can instead open countertrend orders just before the price reaches the level so they can also take advantage of those fast rebounds that often only reach the level.