Supports and Resistances: What They Are and How They Work


The renewed access to financial markets, as a consequence of the development of technological platforms, has made topics such as fundamental and technical analysis more and more topical. Specifically, there is a growing interest in those essential tools for the evaluation of pick up choices of financial products. Let’s take a look at one of the main principles of technical analysis: supports and resistances. Let’s discover its essential characteristics, its functioning and its practical application

What are Supports and Resistances: Meaning and Definition

Before defining the concepts of support and resistance, it is appropriate to delimit the area in which we are moving, deepening in the first instance the meaning of technical analysis.

What is, then, the technical analysis of the market? It is an instrument of price evaluation of one or more assets, in order to formulate a forecast on the future trend of the instrument considered. Unlike fundamental analysis, which elaborates its evaluations in consideration of the economic data of the underlying, technical analysis starts from the initial assumption that the price trend repeats itself cyclically and that, for this reason, it is possible through the graphic analysis of the same, to identify the right moment in which to put in place the negotiation of the asset class.

Technical analysis makes use of some specific tools that allow the graphical interpretation of prices. These include moving averages, Bollinger bands and, of course, supports and resistances.

Wanting to deepen the concept, we can define the support as the minimum price level below which a financial asset stops its fall and begins a potential rebound phase. The concept of resistance, on the other hand, represents the maximum price level beyond which the stock cannot go but is pushed, in the opposite phase, to retrace on itself.

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How they work

The market dynamics that induces the creation of a support is linked to the trend of trading on the underlying. The concentration of sales operations on the security causes a descent of prices which, on the other hand, may induce other investors to buy the same security in view of the more advantageous price. When supply and demand return to equilibrium, a support is elaborated that can determine a sort of hard core of the price that will return to rise or if, broken through, will tend to reach the next support level.

The resistance level, in a similar way, is a consequence of the trend of trading on the underlying. When this threshold is reached, traders decide to sell and consolidate the gain while the value of the security goes down tempting investors to start buying back the security. Also in this case, then, one of two options can occur: either the security stops its race on the resistance level or it breaks through it to reach the next resistance level.

When prices violate a support or a resistance in technical analysis we speak, respectively, of bearish or bullish breakout that represent, as the name says, a breakout phase in the price trend.

Types of Supports and Resistances

In technical analysis it is possible to identify two different macro categories of supports and resistances: static and dynamic.

Static

Static supports and resistances are horizontal segments drawn on essential technical levels (such as, for example, the minimums). Examples of such elements are absolute and relative minima and maxima, descending or ascending Fibonacci retracements and lower or upper limits of a rectangle.

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Dynamic

The dynamic supports and resistances, on the contrary, are lines or curves that are below or above the price line and are placed as obstacles to the continuation of a phase of descent or ascent of prices in place. Examples of such representations are the bearish or bullish trendline, the lower or upper limit of a descending or ascending channel and moving averages. It should be noted that these are constantly evolving concepts that do not remain stable over time.

Psychological

A final consideration, moreover, should be reserved for the so-called supports, or resistances, of a psychological nature such as, for example, the achievement of threshold values represented by round numbers that can represent important thresholds.

Investment Strategies

The analysis of a trading chart is the essential starting point in the elaboration of a strategic investment plan. It is good to clarify, however, that there are no magic recipes; investment strategies are the result, very personal, of one’s own risk appetite and, above all, of one’s own time objectives. Generally speaking, however, we can say that it is essential to quickly identify the essential indicators present in a technical chart and act just as quickly.

One of the best known investment strategies is the identification of the trend of an underlying and the perimeter of application of moving averages. These are, in this case, basic strategies perfectly suitable even for traders who are still in their infancy. Supports and resistances are essential signals in this sense. Technical analysis, therefore, suggests to buy on an established support level and to liquidate positions on an established resistance.

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For more advanced and complex strategies it is possible to read up on binary options strategies (Bollinger bands and RSI indicator), indicators such as MACD, CCI and stochastic.

Advantages and Risks

The advantages of technical analysis based on supports and resistance is evident. The individuation of these indicators translates into the individuation of the right values to carry out one’s own operations of pick up of financial assets also in terms of stop loss as well as taking profit.

The limits are equally obvious. The unpredictability of the markets is such that it can subvert the overall financial picture with rapidity and the theory of historical courses and recourses applied to the markets is yet to be proven.


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