Cryptocurrencies such as Bitcoin, NEO, IOTA, Ethereum, Ripple, Litecoin, etc can be traded on trusted cryptocurrency exchanges or regulated forex brokers as CFDs in a bi-directional manner. This means that you can profit from rising or falling prices by going long (i.e. buying) or going short (i.e. selling). Key to the execution of successful buy and sell orders is the identification of support and resistance areas on the charts.
Cryptocurrencies are highly volatile assets. That means that there is a wide difference between the lowest and highest prices for any particular trading day; a lot more than many currency pairs you will encounter in the forex market. This has advantages and disadvantages. It is possible to get very good returns if entries and exits are well placed and managed, but it is also possible to get really bad outcomes if entries are not properly timed, or are placed too far away from the key levels of support or resistance. But what is meant by support and resistance?
A support level is a price at which an asset finds hard to go below. Due to the difficulty faced by the asset in moving below that price level, this area forms a support for the asset price and is the best place to enter long on that asset. The snapshot below demonstrates support on Bitcoin.
You can see that the lowest points of the candles in focus did not go below the area demarcated by the purple line. This is the support.
A resistance marks an area where the price of an asset finds it hard to move above. This price level is therefore said to be “resisting” further upward movement of the asset.
The chart below shows what a resistance looks like. You can see that the highest points of the candles did not go above the area marked by the purple line.
Establishing Resistance and Support Levels
How can you identify support or resistance? Keep in mind that what reinforces these areas is the mindset and actions of the sellers and buyers in those areas. So you can identify these key areas by using the previous reaction highs or lows.
Method 1: Using Previous Horizontal Key Price Levels
- Consider the hourly chart below for the Bitcoin/USD pair:
- Points 1, 2, 3 and 4 marked in black were previous resistance areas. The point 5 occurs a while later and is an area where the price action of the asset obeyed the previous resistance points. This shows that market players respect that area and there are more short orders than long ones, which causes the resistance area at 5 to form. This marks a good place for a short entry trade.
- The resistance levels represent areas where the selling pressure on the asset pairing subdues buying pressure. Therefore, there is more selling interest.
- Point 1 marked in blue represents a previous resistance. Points 2 and 3 marked in blue are future support areas where buying pressure subdued selling pressure at the same support area as point 1. At these areas, selling pressure wanes. If you sold at point 5, you must set your Take profit area at the blue points 2 or 3.
2. Using Trendlines
Trendlines are usually diagonal in orientation, so are useful in identifying support and resistance in the circumstances of trending prices. See the chart below to see how trendlines form resistance at points 4, 5, 6 and 7, and form support areas at points 1, 2, 3, 9 and 10.
3. Using the Fibonacci Tools
The Fibonacci retracement tool can be used to trace five price areas (by default) that could be used as support or resistance, depending on where the initial trend is heading. The snapshot below depicts a retracement in an uptrend, so the levels can only be used to identify support for long re-entry trades.
Once any potential areas of support or resistance have been identified, they must be validated before they can be used for trade entries or exits.
How to Validate Support/Resistance Levels
- Role reversals can occur if the key levels are broken by strong price action. A violation of support renders this level a new resistance. Break of resistance turns that level into a support.
- Retests of key levels reinforce those levels, making them more valid.
- If increasing volume accompanies price action at a resistance/support level, the trend that forms from those areas is validated.
- Only use recent history when searching for previous support/resistance levels.
When the price action of a currency pair approaches the support and resistance points, one of two things can happen:
- The candles will hit approach the key levels and may even cross above a resistance or cross below a support, but then may retreat and close below the support or above the resistance. In this case, the price action is said to have “tested” the key levels.
- The candles will breach the resistance/support lines and close above/below the key levels respectively. In this case, the key levels are said to have been “broken” or “breached”. This situation may occur after repeated testing of the key levels or if the momentum is strong enough, may occur straightaway.
Support and resistance levels mark key levels at which trade entries and exits can be made. If a trader is LONG on a cryptocurrency, the exit should appropriately be set at the nearest resistance point. Conversely, if the trade position is SHORT, the exit target should be set at the nearest support level.
In this chart above, a short entry at point 5 should have the Take Profit level set at the nearest support level. Using support and resistance for entries and exits helps the trader avoid careless losses that occur from improperly placed entries and exits.
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