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The terms support and resistance are used regularly in binary trading and are essential concepts to understand if traders want to be successful in trading. Support refers to the price level through which a market very rarely falls, whereas resistance refers to the price level that a market rarely surpasses.
Commonly, it is said in technical analysis that broken support levels become future areas of resistance and also that previous levels of resistance become a support. Although this may sound complex, in fact it is important to understand the importance of resistance and support and to take note whenever they reverse roles.
In order to grasp the importance of role reversal between resistance and support, it is first essential to understand the basics about these concepts. They are both technical terms that are used by traders in order to refer to particular price levels that historically have prevented traders from pushing prices of underlying assets in a specific direction.
For example, if a stock has tried to fall below an ascending trendline a number of times over a few months but has failed, despite approaching the line on a number of occasions, this is called a support level as it corresponds to the price level at which the majority of investors feel comfortable to buy the asset, thus preventing the market from pushing prices substantially lower. Conversely, resistance is the term used to describe a situation where an asset’s price struggles to move above a specific price level, this forcing the asset’s price to decline.
Reversals of Support and Resistance
A reversal occurs when the underlying asset’s price can finally break out, going beyond the identified resistance level or support. If this happens, it is fairly common to see the previous support level alter its role, becoming a fresh area of short-term resistance. Although a number of traders are sceptical about whether or not these concepts actually take place, in fact reversals occur quite often. Once the support level or resistance is broken, its role becomes reversed. Should the price fall below a support level then it becomes resistance and if the price should rise above a resistance level, often it becomes support. As a price moves past the level of resistance or support, traders believe that there has been a shift in supply and demand, and this causes the breached level’s role to be reversed. In order for a true reversal to take place however, it is vital that the price makes a powerful move either through the resistance or support.
Round Numbers and Their Role in Support and Resistance
Round numbers are frequently seen as a type of universal resistance and support across many securities. Numbers such as 10, 20, 35, 50, 100 and 1000 are important in resistance and support levels as they usually represent the primary psychological turning points where traders make their decisions to sell or buy. Buyers often buy heavily when prices starts to fall towards a round number, for example $50, and this makes it more difficult for the asset to fall below this level. Conversely, assets start to be sold as it starts to move towards a round number, and this makes it difficult for the asset to progress past the upper level too. The increased pressure on buying and seeling at these levels makes them an important point of support and resistance as well as being primary psychological points.
The Importance of Support and Resistance in Binary Options
Analysis of support and resistance is a key part of trends as it is useful for making trading decisions and for identifying a reversing trend. For example, should a trader identify a level of resistance that has never broken, despite being tested numerous times, they may decide that they should take prifts as security moves towards this point as it is highly unlikely that the security will move beyond this level.
Both resistance and support levels test and confirm trends, so they require monitoring through technical analysis. So long as the price stays between the levels of support and resistance it is likely that the trend will continue, but it is essential to note that any break beyond the resistance or support level will not always be a reversal. For example, should prices move above the resistance level of an upward trend channel, the trend will have accelerated and not reversed, meaning that the price appreciated will be expected to be faster than it was in the channel.
If a trader is aware of these key points of support and resistance, they can use that information to inform the way they trade, avoiding trading at these key points as there is generally much volatility around these areas. Trades should never be made directly at the resistance or support level as often the price will neer actually reach the whole number, hovering around it instead. Trades should therefore be made within a few points of the support level.
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- Fibonacci Retracements To Identify Potential Reversal Levels
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- Classic Market Technical Analysis With Former Resistance/Support Becoming Support/Resistance
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Recommended readings
- Textual analysis of stock market prediction using breaking financial news: The AZFin text system (PDF) (Robert P. Schumaker, Hsinchun Chen)
- Economics Reading Lists (Economics Liberty Library)
- International Trade ([KO] Krugman, Paul, and Maurice Obstfeld. International Economics: Theory and Policy)
