Two of the most basic concepts in the technical analysis of financial markets are both support and resistance. And when we talk about basic concepts, we mean that they are very simple to understand and at the same time they are one of the pillars on which technical analysis is based. First of all, we are going to define what is a support and what is resistance.
- Resistance is defined as a level or price above the current price at which the selling force will stop and eventually overtake the buying force thereby ending the bullish momentum. This causes the price to start falling and even the uptrend to reverse. In a graph like the one shown in the following figure, resistance can be identified as previous highs reached by the price before falling. In an uptrend, resistance can be viewed as higher and higher highs.
- The concept of support for its part is the opposite of resistance. Support is defined as a level or price below the current price, in which the buying force equals and finally exceeds the selling force, with which the downward momentum is stopped, which will cause the price to rise and even the downtrend is reversed. Generally, in a graph, the supports can be identified as the minimums reached before the price begins to rise. In a downtrend, supports can be identified as lower and lower lows.
The following image shows several real examples of support and resistance.
The relative strength of support and resistance levels
Some experts and analysts use a classification of resistances and supports and divide them into strong, medium, and weak. However, there is some controversy about the validity of this classification since it is usually somewhat subjective. However, there are some criteria in which most analysts agree to determine the level of strength of resistance or support. These criteria are detailed below:
- Resistance or support is considered strong depending on how many times it has been tested for the price without having been definitively crossed. In other words, the more times a resistance or support level has been touched by the price, remaining as such, it can be considered that that level is stronger than another that has resisted less time when it has been tested by the price.
- A resistance or support level strengthens as the prices move away from it (it) after having tested it. For example, if the price moves 10% away from resistance or support, this level is considered to be stronger than another from which the price moved only 5%.
- The longer a resistance or support has been in place, the stronger it is. For example, a resistance that has been in place for 2 years is considered stronger than a resistance that is only a few days old.
The trend and its relationship with resistances and supports
When the trends in the price charts are analyzed, it can be seen that they are formed by a series of valleys and ridges that are produced by the movements of the prices. Thus, in an uptrend, there is a series of successive valleys and peaks that are higher and higher, that is, a succession of increasing resistance and support.
When the market is in an uptrend, the resistance levels represent pauses or rest zones in the upward trajectory, which temporarily stop the price action, without being able to do so permanently. For an upward trend to continue, the price needs to exceed the previous resistance level, in such a way that it reaches a new high as seen in the image below.
Whenever the price tests a previous high, the uptrend is in a critical period during which it could happen that the price does not exceed the previous resistance, which would indicate a sign of weakness in the prevailing trend. Likewise, it is necessary that the minimums are successively greater than the previous minimums. In the event that the price of the asset falls and reaches the previous support, there is a sign of weakness in the trend. Finally, if the price falls below the level of the previous support, it is very likely that there is a possible change in the uptrend to the bearish trend as can be seen in the image below.
When the market is in a downtrend, it can be said that the behavior is equivalent to that of an uptrend. A downtrend is made up of successive support and resistance. In this case, the support levels represent pauses or rest areas in the downward trajectory, which temporarily stop the price action, without being able to do so permanently.
For a downtrend to continue, the price needs to exceed the previous support level, in such a way that it reaches a new low. Whenever the price tests a previous low, the downtrend is in a critical period during which it may happen that the price does not exceed the previous support, which would indicate a sign of weakness in the prevailing trend. Likewise, it is necessary that all the maximums are successively lower than the previous maximums. In the event that the asset price rises and reaches the previous resistance, there is a sign of weakness in the downtrend. Finally, if the price rises and exceeds the previous resistance level, it is very likely that it is facing a possible change from the downtrend to the bullish trend.
Change of Roles of supports and resistances during trend changes
So far, resistances and supports have been defined as maximum and minimum levels in market prices. However, one of its most interesting properties is that once they have been significantly crossed, they change their role or function completely, transforming into its opposite. This means, for example, that once a resistance break has been confirmed, it will change its role and become support during successive market declines. In the same way, a support that has suffered a definitive break will also change its role, and henceforth it will behave as resistance during the following bullish movements or impulses.
It is important to keep in mind that the stronger a resistance has been, the stronger it will be considered as support after it has been traversed by price. The same can be said with respect to support that has suffered a break. To better understand what the role changes of resistance and supports consist of, the following images can be analyzed.
Support and resistance breakdown
Much is said about breakouts and significant penetrations of resistances and supports, in fact many expert traders operate based on trading strategies based on these breaks. However, it can be said that there is a certain degree of ambiguity or uncertainty regarding what is really a significant break in one of these levels, since not infrequently we are faced with what seems to be a definitive break only to realize that the price ends bouncing back, which is known as a false break. There are not few times that an operator is caught in a situation of these. However, there are certain criteria in this regard, among which we can highlight the following:
It is based on the well-known Dow Theory and states that the trading volume should increase as the price of the asset breaks and advances above resistance or below support. If it is observed that the volume begins to decrease as the break occurs, we are probably facing an unreliable and short-lived break that we should not enter.
Expert traders usually use a certain percentage to establish whether resistance or support has indeed been broken. For example, for very important levels, this percentage should be 3%. In case of being in an uptrend, the price of the asset must exceed the resistance level by 3% for it to be considered that it has been crossed and it can be assumed that a role change has occurred (now the resistance is support). Similarly, the price must fall 3% below a support level during a downtrend for a significant breakout and role reversal to be considered to have occurred (now support is resistance). In those volatile or dynamic markets (in which the movements of the prices are more pronounced),
Criteria of daily closing:
A breakout is considered valid if the price closes above (below) the level of resistance (support) that has been exceeded by prices in a given period. If the Dow Theory is applied, intraday breakouts are not According to this theory, only daily closing prices are considered valid, however, its principles can also be extended to weekly and even monthly closings used for long-term market studies. The daily closing criteria can be applied to any time frame; you just have to keep in mind the period you are working with and the price closings that occur during it, after having crossed support or resistance.