Supports and Resistances (Series 6: Bee_A_Trader)

in LeoFinance2 years ago

After covering the basics about candlesticks in the last article, let's dive a bit deeper to understand the basics of supports and resistances in a market.

If you don't know what supports and resistances mean, or of you are a newbie in trading, you might have come across people mentioning these terms; and if you are clueless and want to know more, this article is exactly for you.


In simple terms:

  • Support price is something at which we can expect more buyers (which stops the price from going down further)
  • Resistance price is something at which we can expect more sellers. (which stops or resists the price from going up further.

We will have a look at how to identify them soon enough and how to take trades based on Supports and Resistances (S&R)

Let me try to recreate an ideal scenario for a support and resistance, along with breakout from a resistance, and breakdown from a support in the following ideal market scenario:

image.png
(Note: I'm a very poor graphic designer, so yes I used MS paint lol)

In simple terms,

  1. A resistance is a zone which will "resist" prices from going higher

  2. A support is a zone which will "support" prices from going lower.

  3. A breakout means price has overshot the resistance, and buyers have overwhelmed sellers, which eventually turned a resistance into a support.

  4. A breakdown means price has fallen through the support, and sellers have overwhelmed buyers, which eventually turned a support into resistance.


Disclaimer: I'm not a certified financial advisor, and even though I've been trading for quite a few years, I urge people reading this, and my other posts to #DYOR (Do your own research) before taking any decisions! There is no guarantee whatsoever that you will become a profitable trader.
Of course I'm going to help you out if you have some queries/doubts, so feel free to let me know in the comments, or on Twitter :)


If you have followed on since the start of the series, I have covered a basic idea about supply and demand in the first candlestick educational article. Do check it out and follow the link in case you have missed out.

  1. At higher prices, the number of sellers will increase because as price goes up, it will be more attractive for the seller to sell it
  2. At lower prices, the number of buyers will increase, because it will be more attractive for a buyer to buy it.

image.png

(Note: Well, in reality they are not straight lines, I've drawn them like straight lines, for simplicity of this content)

Now the question comes, why am I bringing supply and demand in covering what are supports and resistances?

Well, imagine the scenario below:

image.png

Now the next question may arise:

Why will the buyers buy at low prices and the sellers sell at high prices?


Well, buyers and sellers keep on buying and selling in the market all times. If the price is low,
a small buyer can buy up a large number of assets, effectively reducing the supply of the assets. Similarly, at very high prices, sellers can gain a large amount of money by selling a small amount of money! So this is why there are supply and demand in-equilibrium, all time in the market, which is why the price keeps going up and down.


Now consider the equilibrium zone in the below example:

image.png

We see that at $5, in this case, the number of buyers and sellers are almost equal but this happens in an ideal market. In reality, buyers may not be willing to buy the same amount every time to get the same amount of assets, or the sellers also won't be willing to sell the same amount of assets every time at the same prices.

So this creates inefficiencies in the market.

So, theoretically, from the equilibrium, demand is either going to increase (which means buyers will step in to buy assets), or the supply is going to increase (means sellers stepping into the game to sell).


Now let's have a look at a real support and resistance level on the chart:

Ideally, textbook definition states that a support (or a demand zone) is an area where buyers are expected to step in, to buy an asset.
Usually they are horizontal price zones, but there may be variations based on a lot of external factors.

I'll take the example of a supply zone, and how that turned to a demand zone in the below example:

*Note: This is a recent example, and is based on the last 1 year of price action.

image.png

As you can see, I have broken down the chart into three distinct zones (the blue vertical lines)

Consider the first zone: Every time price reached the demand zone, it went up, as buyers bought the asset.

Consider the second zone: This happened after the support was breached, and there were less buyers than sellers at that zone, so the sellers overwhelmed the buyers, and that became the resistance.
Every time the price reached that zone, price went down. Which means there was the supply zone.

consider the current scenario: This happened after there were less sellers than buyers, and the buyers overwhelmed the sellers. This is the current price action, which means there is demand for BTC.
This is one reason I'd ask that you stack some BTC when price reaches $9000-ish levels. (Of course it can still reach $8000-ish levels, but those will be temporary wicks imo.

So by supports and resistances, we are going to find those levels or zones on the chart, where we think buyers will step in to push prices higher (from support) or sellers will step in to push prices lower (from resistance).


Let's have a look at the more recent price action, on a 4 hour chart to identify these zones.

image.png

On looking at the 4 hour chart, we can see that there is a price zone, between 11150-ish levels to 11300 levels, which is showing some action.

I have numbered the reaction areas from 1-7 on the image, so please have a look and zoom in, for better visibility. (If you are unable to zoom, follow this tradingview link: https://www.tradingview.com/x/r9Bn6TjQ/)

  1. Initial price action shows that there was some sort of supply zone, as the price got rejected a few times, but soon bulls stepped in and pushe prices back up, so the prices went up.
  2. Bulls are still not sure about the price action, as bears are also strong, but they step in even after they see a big rejection, which means there is hope in the market.
  3. Bulls become extremely comfortable in buying the asset whenever the price comes to these levels, and bears are getting a bit cautious.
  4. Bears are a bit fearful of driving price down, and bulls are now euphoric, and it looks like most people bought in!
  5. Now comes the catch: From technical standpoint, when the price moves up from support every time, and as bulls go euphoric, there will be a time, the market will eventually have far less buyers. So if there are no buyers, the demand will fall, and that zone will now turn into a supply zone, which means, bears have taken control over the bulls.
  6. This is the Daily contracted chart, (refer the above image) showing the yearly demand zone, so new buyers have stepped in again, and have pushed the prices higher.
  7. At the same time, on a smaller timeframe, there is a supply zone,or resistance, which means, bears are still strong, and are hopeful that the prices will go down from here, for short term.

This answers the psychology behind how we find the market demand and supply zones.

Now we need to make a few assumptions:

  1. How much time a particular zone held as support or resistance
  2. How much impulsive the movement was before/after hitting the supply/demand zones, or supports and resistances.
  3. More recent data is always and should always have more more weight
  4. Is the area a major psychological zone? (example: Bitcoin at $10k is a psychological zone! Similarly, Bitcoin at the all time high of $20k is another psychological resistance.

Summary:

  1. Excess supply builds up selling pressure, as it increases supply, and prices are expected to go down after hitting resistance, and traders should look forward to sell/short the asset
  2. Excess demand builds up buying pressure as it decreases supply, and prices are expected to go up after hitting a support zone., and traders should look forward to buy/take long on the asset

Long/mid term supports and resistances are extremely important to take good swing trading opportunities

Also remember:
If a support is broken, it turns into resistance
If a resistance is broken, it turns into support.

If a support was expected to be very strong, and if it flips into resistance (means price going down), the resistance will also be extremely strong.


To identify a good support/resistance zone, make sure there are at least two sharp reversal points.
These are also known as swing highs or swing lows.

A swing low is when price makes a low and is immediately followed by two consecutive higher lows, or the price moves up, in layman terms. Similarly, a swing high is when price makes a high and is followed by two consecutive lower highs on the chart, or which means that the price goes down, and this way, you can identify trends based on these market structures.

Now you must remember that if a support gets tested multiple times, it becomes weaker and weaker, and the price should eventually break down. Because of the laws of supply and demand.
Similarly, if a resistance is tested multiple times, it becomes weaker and weaker and the price should eventually go higher.

Also this may not happen every time, so to increase the probability of whether a support will break down, or break above, you should identify and try to analyse the swing highs and the swing lows.

The theory is beyond the scope of this article, and for simplicity, I'm going to cover about this when we dive deeper into market patterns, so you'll get a deeper understanding about them.


If you are interested, you may search for things like: Higher highs, lower highs, higher lows, lower lows on a chart, and how these affect prices, and you can apply the same concept of demand and supply to identify more advanced trendlines and support and resistance zones.

In the next article I'll be covering about trendlines, and how to use them for more efficient trading, and then I'll move on to a few chart patterns with some examples of how to trade them, so stay tuned! :)


Further reading/external sources:

https://www.investopedia.com/trading/support-and-resistance-basics/

https://www.desiretotrade.com/powerful-way-to-draw-support-and-resistance-zones/

https://zerodha.com/varsity/chapter/support-resistance/

https://tradingsim.com/blog/swing-high/#:~:text=A%20swing%20low%20is%20when,by%20two%20consecutive%20lower%20highs.


If you liked the article, please this with your friends and circles, and also upvote this, so that I get motivated to keep sharing market insights and analysis:)


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As a support/resistance trader myself, I love seeing detailed education posts like this.

Keep up the great work!

Posted Using LeoFinance

Thanks a lot for the support ! :)
Much appreciated...

Posted Using LeoFinance

Excellent post!
Keep educating the masses!
@tipu curate

Thanks a lot for curating my content! :)
Much appreciated

Posted Using LeoFinance Beta

WE NEED MORE "EDUCATIONAL" POSTS like YOURS ;-)
There are many uninformed people around.

Sure! I'll try my best to share my knowledge here :)
A lot of posts to come!

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