Our previous article discussed the different types of crypto price charts and how it simplifies analysing the cryptocurrency market.
We are moving forward with the next important topic and widely used concept in technical analysis, i.e., identifying the support and resistance levels.
Just like every person keeps a different view on the market, similarly, you will find a difference in perspective on support and resistance levels. The difference in perspective is quite normal in the market as each individual has a different understanding of the support and resistance levels.
In this guide, you will learn about the concept of support and resistance and different ways to identify the levels.
What are Support and Resistance in Crypto Trading?
First, let’s take a look at a basic price chart.
You can see, the price first moves up then pulls back a little and then again moves ahead, continuing the cycle. But, in each fall, the price drops only to a certain level and that level here is termed as support. And, similarly, in the uptrend, there is resistance. So, what are these both terms?
The support is a zone, where there is a concentration of buyers in the market. In simple words, the level at which a large number of buyers are holding their position in the market. Once they start to sell, only then the price will fall below that level.
And, the resistance is a zone, where there is a concentration of supply in the market, hence resulting in weakness in the strength to continue moving higher. When there is a surplus of sellers in the market, the price tends to drop from that level.
The support and resistance is more a psychological play of buyers and sellers in the market.
Using the support and resistance level, many traders plan their trading strategies. For example, buying when the price is nearing the support level or selling when it is nearing resistance. Or, buy when the price is above the resistance level and sell when the price is below the support level.
Trading using support and resistance is the most popular strategy in the market due to its simplicity. But, to trade successfully, you need to know how to plot the support and resistance lines, which we are going to discuss next.
Identifying Support and Resistance Levels
Plotting or identifying support and resistance levels doesn’t need you to do number crunching or perfect any skills. You can visually identify the levels using trend lines and other indicators. Let’s have a look at some of them.
Trendlines are the most basic and popular form of technical analysis in cryptocurrency trading and are often the most underutilised.
To draw a trend line, you need to draw the line correctly along the bottom of the support and resistance areas, or the valleys and peaks, like in the images shared below.
In the above price chart of XRP/INR, we can see both a descending trendline (downtrend) and ascending trendline (uptrend). You can see, the ascending support line was providing good support to the prices, but once the price went below that trendline, it is now acting as resistance.
Here is another example of a descending trendline that is acting as a resistance.
The below image shows the sideways trendline and is considered more effective in trading.
To draw a valid trendline, you should keep the following points in mind:
- A valid trendline should have at least two tops or bottom, but it takes three to confirm the trendline
- Steeper trend lines are less reliable
- Horizontal (sideways) trendlines become stronger the more times they are tested
Moving averages is another popular technical analysis tool for traders. It provides information about the direction of a market trend. It helps to smoothen out the price data by constantly updating the average price of the cryptocurrency.
Why do moving averages matter in the cryptocurrency market?
The random and short term price fluctuations in cryptocurrencies make it difficult to analyse the market correctly. By using moving averages, you can easily filter out the noise and identify the market’s overall trend.
It is calculated by summing the daily closing price of the cryptocurrency over a certain period and dividing the sum by the total number of periods.
The popular moving average timeframes are 20, 50, 100, and 200 Days moving average (DMA)to identify the support and resistance level.
For short term trades, shorter DMA is effective as compared to the longer DMAs.
In the above daily price chart of BTC/USD, you can see the 20 DAY EMA is providing immediate support. Also, the overall trend of the market in the short term looks quite positive.
Types of Moving Averages
There are two moving averages, Simple Moving Average (SMA) and Exponential Moving Average (EMA).
SMA is calculated by summing up all the closing price points in the chosen time frame and dividing the sum by the total number of days.
On the other hand, the exponential moving average is the weighted average of the most recent price points of the chosen period.
So, what’s the difference between the two and which one should you use?
The difference between the two moving averages lies in the sensitivity. An exponential moving average tends to show more sensitivity to the latest price changes and helps traders and investors gauge the trend better.
Therefore, using EMA helps to spot the support and resistance levels accurately.
Whether you are a trader, investor or beginner in the crypto market, you should know the process of identifying the support and resistance levels. This will help you avoid making the wrong trades, like buying at a high price, where the market is struggling to break above or sell cheaply.
The above two ways, plotting trendline and moving averages of identifying support and resistance, are the most common, but there is one more indicator called Fibonacci Retracement.
We could have discussed this here, but you know, it’s a little complex, and we don’t want you to get confused with one more concept of support and resistance at this stage.
Until then, you can play around with the price charts and identify different support and resistance levels.
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Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.
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