One of the most important decisions of every investor is identifying the right time to buy and sell their assets in the market. Fortunately, there is a common way of determining this. Technical analysis, which includes analyzing historical data in order to predict future price movements, holds a certain concept that could recognize potential market timings. This concept involves making use of support and resistance indicators.
What are support and resistance indicators?
Support and resistance is a concept applied in technical analysis that focuses on analyzing the price movement of a security. It shows the tendency of the market trend to stop and reverse at certain preset price levels. These levels called “support” and ‘resistance” levels are denoted by repeated marks of a certain price in the trend without a breakthrough of the level.
Support level – is a level where the price tends to find “support” in a falling trend. It acts like the floor which prevents the price from falling further. As soon as the trend hits the support level, the price is more likely to bounce back to a reverse direction instead of breaking through it. However, there is still a possibility that a support level is breached and will likely to continue falling until it hits another support level.
Resistance level – is same as the concept of the support level, but in a different direction. It is a level where the price tends to find “resistance” in a rising trend. It acts as the ceiling which prevents the trend to rise further. Again, this means that as soon as the trend hits the resistance level, the price is more likely to bounce off towards a downward direction instead of continuing the rising trend. There is also a possibility that a resistance level is breached and is likely to continue rising until meeting another resistance level.
Support and resistance levels can be identified using trend lines or by using pivot point calculations. A specific level becomes more significant as it is more often “tested” by the trend.
If a price breaks through a support level, that certain level often becomes a new resistance level. The opposite is true as well. If the price breaks through a resistance level, it is more likely to find support at that level in the future.
Investors often use the concept of support and resistance in entering and exiting a trade. A basic investment strategy is to buy a stock at a support level and then sell it at the resistance. Short sellers also use this strategy by shorting at a resistance level and then covering the short once it reaches a support level.
2 types of support and resistance indicators
The first one is called the proactive method. Proactive support and resistance methods aim to predict the levels, often in areas where price has not actually been. They are based on analyzing the current price action to predict the future price action. Some of the methods to determine proactive support and resistance levels are measured moves, swing ratio projection, trend lines and moving averages, etc.
The opposite of proactive is the reactive method. These indicators are formed directly as a result of the current price action and volume behavior. Some methods of determining these levels are price swing lows/highs, certain candle patterns, volume profile, open gaps, etc.
Knowing how to recognize support and resistance levels plays a crucial role when it comes to making trading decisions. It helps in identifying the right time to buy and sell a security through technical analysis. Even if support and resistance levels are merely speculations, having a solid strategy in understanding the market trend is still better than blindly making major trading decisions.
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