What are support and resistance levels?

'Support' and 'resistance' refer to price levels on a crypto trading chart that indicate a potential reversal of a trend for an asset. An essential part of technical analysis, traders aim to estimate these price levels to help inform the positions they open. As such, support and resistance are fundamental concepts traders of all experience levels need to understand.

Let's take a closer look. In this article, we'll explore what support and resistance levels are and how they're calculated. We'll also explain how to trade using support and resistance levels, and discuss the benefits and limitations of this essential tool.

TL;DR

• Support and resistance levels are fundamental technical analysis tools traders can use to predict a potential price change for a crypto asset.

• 'Support' refers to a price area where selling pressure eases and buying pressure starts to take over.

• 'Resistance' refers to the opposite — buying pressure becomes exhausted and selling pressure increases, potentially causing a reversal of the prevailing trend.

• Traders can use various methods to calculate support and resistance, including Fibonacci retracement, studying past highs and lows, and measuring trendlines.

• The tool has many benefits, including finding possible breakouts and helping to manage risk. However, it has some limitations. This includes the potential for false breakouts and vulnerability to high volatility.

• It’s wise to use support and resistance in combination with other technical analysis tools for more informed trading.

What are support and resistance levels: a closer look

One look at a crypto exchange order book reveals the constantly fluctuating forces of supply and demand on a crypto asset. Supply and demand — the buy and sell orders being placed by traders — influence where support and resistance levels could be found.

Support explained

Support is encountered during a downtrend where supply is greater than demand. In other words, selling pressure has eased and buying pressure has increased. Any continued bearish (selling) positions would have trouble penetrating this level, potentially leading to a reversal towards higher prices or a period of sideways movement.

Resistance explained

Put simply, resistance is the opposite of support. Here, a period of rising prices slows and meets a ceiling as bullish (buying) pressure becomes exhausted and traders are more inclined to open a sell position. Just as when a support level is reached, a resistance level can also lead to a reversal of the trend, or sideways movement.

Example of support and resistance levels

Source: TradingView

Let's take a look at a real-world chart to illustrate support and resistance levels. The above chart shows BTC/USDT prices and features a helpful technical analysis tool traders can use to identify support and resistance levels — Fibonacci retracement.

On the far left, we see the BTC prices — 59,568.7, 61,951.1, and so on. To the right of the BTC prices, we see the Fibonacci ratios — 1, 0.786, 0.618, and so on. The horizontal lines showing each Fibonacci ratio align with support and resistance levels across the chart's time horizon.

In the above, a support level can be seen along the 0.236 ratio, where the red candles, indicating selling pressure, make way for bullish green candles before eventually retesting the support on two further occasions. Meanwhile, a resistance level can be seen at the 0.618 ratio. This level is tested twice after a breakout past this price during early July.

When resistance becomes support

The chart above also demonstrates an influential factor of support and resistance levels, which is when either level is broken and their roles reverse. Here, when support is broken, it can become resistance, and vice versa. We see this occurring at the 0.382 level in the chart above between August and September. Here, prices break through the resistance level, as evidenced by the long body of a green candle. Prices then find support at this level and resistance at the 0.618 level before trending downwards and breaking through the support.

The factors influencing support and resistance levels

It's important to keep in mind that although historical charts show support and resistance levels, they aren't set in stone for the future. There are many factors influencing where these levels are found and when prices break through them unexpectedly. Let's look at some of these factors.

Sudden volatile events

It's well known that crypto markets are volatile, with prices often fluctuating in response to external events. Moments such as conflict, political upheaval, and even natural disasters can have a ripple effect that impacts crypto prices, wiping out support and resistance levels.

Trading volume

A high trading volume can strengthen a support level. As prices fall to the support level, sellers encounter strong buying pressure, halting the drop in prices and potentially causing a reversal.

Psychological levels

In some situations, round numbers can represent support levels as traders are drawn to these figures for their buying points. Studies have shown that volume clustering can occur around round numbers. As mentioned above, a higher volume of trades at a certain price can halt a trend and lead to a reversal in prices.

Previous highs

Previous highs sometimes represent a resistance level that's difficult to breach. That could be due to traders fearing a repeat of past rejections at a resistance level, which causes them to sell for fear of a reversal.

Liquidity

Both support and resistance levels can be more vulnerable in markets with low liquidity. Here, the lack of volume means buyers and sellers are easily exhausted, leading to a reversal in trends.

How to calculate support and resistance levels

There are multiple ways to calculate support and resistance levels using technical analysis and historical data.

Previous highs and lows

One of the simplest ways of calculating support and resistance levels is to look at past highs and lows. When calculating support, look for past lows that prices have risen from. Similarly, for resistance, look for previous highs where prices have pulled back from. A support or resistance level that's been touched but not broken multiple times in the past could indicate a repeat in the future — but there are no guarantees.

Fibonacci ratios

Our example chart above demonstrates how to use Fibonacci retracement to identify areas where prices may find support and resistance levels. As its name suggests, Fibonacci retracement uses the Fibonacci sequence as the foundation of its analysis. The theory suggests that after a strong price move, there's a possibility that prices will retrace back to a level that corresponds to a Fibonacci ratio, before the trend continues. As such, traders can use these ratios to predict support and resistance levels.

Trendlines

Trendlines are another relatively simplistic way of identifying potential support and resistance levels. The first step is to determine if the market is currently in an uptrend or a downtrend. If it's in an uptrend, mark two or more lows. If a downtrend is seen, mark two or more highs. By drawing a straight line between these points, you can see where support and resistance levels might fall along the future time horizon.

Benefits and limitations of support and resistance

Although calculating support and resistance levels has many benefits for crypto traders, it's important to also be aware of the tool's limitations before you apply it to your trading strategy.

Benefits of support and resistance levels

• Multiple methods of analysis: Because there are multiple ways of calculating support and resistance levels, you can double or triple check your calculations with multiple tools before jumping into a trade. In theory, that could mean more reliable estimates, but in crypto, nothing's certain.

• Supports risk management: Risk management is fundamental to successful crypto trading, and support and resistance levels are a helpful tool towards this end. By calculating these levels, you also identify areas to place a stop-loss or take profit — two essential risk management tools.

• Identifies potential breakouts: When prices move beyond support or resistance levels, it could be a sign of a price breakout and further decisive movement in that direction. Although you should be cautious of false breakouts in this scenario, it could signal a new trend and, as a result, fresh opportunities for new positions.

Limitations of support and resistance levels

• False breakouts: We touched on false breakouts above, and they're a key limitation to be alert to. A false breakout occurs when prices temporarily break through a support or resistance level before quickly reversing. The risk here is that you react to the breakout expecting a continuation of the trend, before the reverse causes a liquidation of your new position.

• Based on historical data: Like many other forms of technical analysis, support and resistance levels are calculated based on historical data. Past performance can never be a foolproof indicator of future prices, especially given the volatility of crypto markets. This limits the accuracy of the tool.

• Vulnerable to volatility: On the topic of volatility, the tools and any positions based on it are vulnerable to large price swings that can see prices smash through support and resistance levels. This is why it's key to combine the tool with other technical analysis methods before you trade, so you can make fully informed decisions.

The final word

Support and resistance levels are a fundamental part of crypto technical analysis, revealing potential areas of a trend reversal. Although on the surface they may appear simple to use, it's important to keep in mind the volatility of crypto markets and their ever-changing nature. As such, it's wise to combine support and resistance with other technical analysis tools, so you're well-informed before trading.

Interested in expanding your knowledge of crypto technical analysis tools? Check out our guide to understanding and trading bear flag patterns, and our article on Bollinger Bands.