Crypto Technicals: Support and Resistance Levels
Some people say that you use fundamental analysis (FA) to decide what to buy, then you use technical analysis (TA) to decide when to buy or sell. Using TA for cryptocurrencies, you look at the price charts and find various indicators and signals to tell you about the price trends.
The chart is the data, which is just plain raw numbers that do not make sense. You have to break down and make sense of the data so as to gather certain pieces of information about the price or the market. Therein, you can decide whether or not to act upon these pieces of information, which are really your interpretation of the data.
What Are Support And Resistance Levels?
As the price of a cryptocurrency goes up, there are certain price levels where it seems to stagnate and does not breach beyond the price. That is the resistance level.
Conversely, when prices go down but seem to be holding strong at certain price levels, that is the support level.
What Is The Science Behind These Levels?
Price of an asset goes up when people are unwilling to sell it for the existing price. Hence by negotiating a more expensive price, a buyer can be matched with a seller.
Resistance levels exist because a lot of people are selling the asset at those prices. Whether it is cashing out for profits or selling because of sentiments, the sell orders are constantly being met by the buy orders. Hence, prices fluctuate but do not seem to break beyond the resistance level.
On another hand, support levels are established when a lot of people are buying up an asset at a particular price. They believe that this is a value-for-money price and so the buyers snap up the sell orders at the price, and the price does not drop any further.
How Do You Find These Levels?
Support and resistance levels are determined across a period of time by finding the point of inflections, which are the points of the U-turn in the price charts.
Intuitively, if you keep track of an asset's price over the year and you are highly sensitive to numbers and with an extremely good memory, you will have a sense of what is the most supported or resisted price. However, that is too taxing for most people. Just look at the charts.
If the price chart only shows just one instance of a U-turn, then it can be a support (U-shape) or resistance (inverted-U-shape). However, having just one instance is not a robust measure. Instead, you should look at multiple instances where prices make a turn, which is also why it has to be determined across a period of time.
In the above example, you can see that the yellow boxes indicate key resistance levels over the years while the blue boxes were drawn from multiple points of support. One thing to take note is that you have to account for the time frame that you are measuring.
The shorter blue and yellow box occurred in the short run, whereas in the longer term, you have to paint the bigger picture. The chart will also change when you are looking at the Weekly Candles, Daily Candles, or different Hour Candles.
Hence, the chart you use depends on whether you are planning to hold the position for long or to make a day trade. You should also consider the long-term trends against the short-term trends.
What Can I Do With These Levels?
The simple way to look at it is to buy at support levels and sell at resistance levels, as opposed to buying and selling at random times. These levels become price bands for investors to buy and sell.
However, it is more complicated than that. Often we are looking out for breaks above the resistance levels or below the support levels. This is an indication that we are headed to the next support or resistance level, so that is where you can initiate a trade.
When a resistance level is breached and prices go beyond to new levels, the former resistance level will likely become a support level when price reverses downwards. Similarly, support levels can become resistance levels.
What all these means is that these price levels are just recommended price bands to execute buy and sell orders. To decide whether you want to buy or sell at a particular price level, you need to use other ways of reading the charts i.e. other signals and indicators, to give you more information, so that you can make a more informed trade.
In the Ethereum chart above, a mix of trend lines (the vertical lines) and moving averages (the curved wavy lines) were used to complement the analysis. Without paying too much attention to what the trend lines and MA mean, can you guess where the predicted price will be next?
Summary of Lesson
Support and resistance levels are one of the most fundamental aspects of TAs. After you chart the zones of support and resistance, it gives you more information about the market, but you still have to find other information to help you make your trade; see trend lines, price channels, moving averages, and chart patterns.
Technical indicators are tools for you to trade the market, and every trader has his own preferred set of tools. Imagine you want to hang a portrait on the wall, you could use a drill to fix the nails in, or you could use a nail and hammer, or you can decide to just use adhesive materials. Every method works differently and all of them can be equally effective
Hence, in technical trading, it is essential to understand how the indicator works and its limitation, so that you can use the most appropriate tool for the job required.
Charting Platform: Trading View (www.tradingview.com)
More information about qualitative assessment of cryptocurrencies and trading strategies can be found in my book, Rolling In Crypto.
Check out my Medium blog for more crypto-related articles.