Whereas fundamental analysis uses data to determine an asset’s fair value (and making a purchase decision by comparing that fair value to an asset’s current price), technical analysis relies solely on past price movements and trading volume.
Support and Resistance Levels
In technical analysis, support and resistance levels are price points when momentum regularly stalls and changes direction. At support levels a falling price is expected to gain support and turn upwards due to a high buying demand at a lower price; at resistance levels a rising price is expected to hit resistance and begin to fall due to high selling demand at a higher price.
Let’s identify a few support and resistance levels and then learn how they can be useful. Note that long-term investors should look at a longer-term chart such as a daily chart, like the ones I’ll be using.
The green highlight across the chart shows a support level and the red highlight shows a resistance level. Chart from TradingView.com.
Note that there is no exact price for a support or resistance level; instead, the levels are ranges. In the ARK to USD chart we can clearly see a long-term support level around $2.20 and a resistance level around $3.20.
Support and resistance levels can have strength. The more times they are “tested” by the price approaching but not surpassing them, the stronger the level is and the more difficult the level is to pass. Notice how the $3.20 zone has been approached but not passed on several occasions.
Moreover, there can be multiple support or resistance levels, and levels can be broken down by whether they are long or short term. For instance, early on in the chart a resistance level is found around $2.60, and about half-way into the chart a resistance level is found around $2.80.
Breaking Out Helps Identify New Trends
Once price moves past or breaks through a resistance level, the resistance level can turn into a new level of support, signifying an emerging upward trend.
The zone around $400 was a long-term resistance level until a breakout. Afterward, the $400 zone turned into a support level. Chart from TradingView.com.
The opposite is also true: prices that break through the support level can signify a coming downward trend.
But beware of false breakouts. Crossing a support or resistance line doesn’t always mean that a new trend has begun; it is a signal that a new trend might have begun, and is a reason why you should never base your decisions on one indicator alone. You can see an example of a false breakout at the beginning of the ARK to USD chart we looked at earlier.
Also, it’s worth noting that psychology can play a big part in resistance and support levels, and certain numbers, such as multiples of 10 or 100, can turn into a psychological barrier of sorts. For example, look again at the ETH to USD chart, and notice that the long term resistance level was $400, and as the price varied during the breakout, many of the larger momentum changes occurred near $100 increments.
That’s Great And All… But How Do I Use Support and Resistance Levels?
Support and resistance levels are just one set of indicators an investor can use, and they should never be the sole reason to purchase an asset.
That being said, once you have already identified an asset to invest in, support and resistance levels can be very useful when placing buy or sell orders: you may not want to purchase an asset if it is close to a strong resistance level or sell an asset that is close to a strong support level.
Furthermore, using support and resistance can help you minimize price risk when buying the asset, or the risk that an asset’s price will fall directly after you invest.
For example, let’s say I’ve done my homework and have decided I want to buy $6,000 worth of bitcoin. I could invest that $6,000 all at once at the current price, or I could split up my investment and place a series of laddered orders according to support levels.
Notice how the highlighted support levels create a “ladder” across the chart. Chart from TradingView.com.
Using the chart and support levels above, I may devise a plan similar to the following:
Buy $2,000 worth of bitcoin at the current price of $8,700
Put in an order to buy $2,000 worth of bitcoin at around $8,000
Put in an order to buy $2,000 worth of bitcoin at around $7,000
Of course there is no guarantee that bitcoin will drop in price, or that it would stop dropping at the lowest support level. But consistently using a strategy such as this can help an investor accumulate more assets per dollar invested, as some assets will inevitably drop below the price of your initial entry point.
Support and resistance levels can be useful tools once you’ve already identified assets you’d like to invest in, but keep in mind they are not fool-proof and should be used as part of a broader investment strategy.