Now let’s look at a resistance level. As we can see, the price was in a downtrend. But after each bounce, it failed to break through the same area multiple times. The resistance level is formed because the bulls (buyers) were unable to gain control of the market and drive the price higher, causing the downtrend to continue.
Price unable to break an area of resistance.
How traders can use support and resistance levels
Technical analysts use support and resistance levels to identify areas of interest on a price chart. These are the levels where the likelihood of a reversal or a pause in the underlying trend may be higher.
Market psychology plays a huge part in the formation of support and resistance levels. Traders and investors will remember the price levels that previously saw increased interest and trading activity. Since many traders may be looking at the same levels, these areas might bring increased liquidity. This often makes the support and resistance zones ideal for large traders (or whales) to enter or exit positions.
Support and resistance are key concepts when it comes to exercising proper risk management. The ability to consistently identify these zones can present favorable trading opportunities. Typically, two things can happen once the price reaches an area of support or resistance. It either bounces away from the area or breaks through it and continues in the direction of the trend – potentially to the next support or resistance area.
Entering a trade near a level of support or resistance area may be a beneficial strategy. Mainly because of the relatively close invalidation point – where we usually place a stop-loss order. If the area is breached and the trade is invalidated, traders can cut their loss and exit with a small loss. In this sense, the further the entry is from the zone of supply or demand, the further the invalidation point is.