Trading is not only technical analysis, using indicators and clicking on the Sell or Buy button. There is much more behind it. There is a human component. Human emotions really matter also in the trading world. Today I will discuss the psychology behind support and resistance levels.
Support and resistance from the psychological point of view
Support and resistance levels are commonly used in technical analysis. They indicate the points where the trend may pause or reverse. The support line shows where the downtrend may temporarily pause and the resistance where the uptrend. Support and resistance lines set some boundaries (which of course can be broken with time). The market sentiment and individual emotions have an influence on them.
The price on the support/resistance levels and traders behaviour
We can easily distinguish three types of market participants. The first group is long that is awaiting the price will increase. The second group is short waiting for the price decrease. And the third group is on the sidelines without a decision made yet.
What happens when the price grows from the support line? The traders from the first group happily watch the price increase. It is possible they will buy more if the price falls again to that support. The second group is not so happy, they reconsider their decision and may buy to cover. And the traders from the third group may finally decide to buy when the price moves to the support again. As you can see, the growth of the price from important key levels has a large impact. If all groups buy, the support will be even stronger and the price will probably bounce from the level again.
However, the price may also cross the support line and fall. This will also cause many reactions. The traders from the first group will want to limit losses and can wait for the price to rise up to the previous support which now acts as resistance. The second group is now pleased, and they may want to add to their position when the price climbs to the level again. And the third group may enter the sell trade believing the price will be falling.
As you can see, there is always a lot of responses to the price reaching the key levels. The same, though reversed, applies to the resistance line.
The price moves continually. It reaches support or resistance, rebounds a couple of times and finally breaks the line. What was previously the support, convert into resistance. And when the resistance line is passed by the price, it begins to act as the support.
In our example below, we use a 30-minute timeframe. Nevertheless, you will be able to observe this phenomenon on different types of charts and timeframes.
Emotions on the chart
You will experience many emotions during your trading journey. We often talk about fear, anxiety, greed and herd instinct as they influence traders’ decisions significantly. And the chart reflects what is a general trend.
Can you identify emotions in the paragraph about how traders react to the price reaching support/resistance? In case the price was decreasing and nearing the support, the long traders happily were adding to their positions. But short traders were feeling fear of losing their funds, so they began to buy to cover. This situation shows herd instinct too. The support and resistance are getting stronger as the traders are prone to accumulate near these zones.
Anchoring is when the traders use some information subconsciously and base their decision on it. For example, when the support and resistance were formed in the past at some particular levels, an anchor is created, and the traders expect these levels will be valid also in the future.
Likewise, the traders believe the price will achieve levels that include round numbers (as they fall into memory better), 52-weeks lows and highs and historic events for instance new market highs. When something was important in the past, it is expected to be the same in the future. Attention is focused on these levels and anticipation and euphoria generate traders responses.
Traders use support and resistance zones frequently in technical analysis. They draw them with horizontal lines, trendlines or other tools such as Fibonacci retracements.
Support and resistance are the levels that the price seems not to overcome. The price tends to test them repeatedly but eventually, it breaks through them. Oftentimes, the support becomes resistance and the previous resistance begins to act as support.
The levels are used to make trading decisions about entering and exiting transactions. The market sentiment and human emotions have an impact on these zones. Investors analyse the past and remember consciously or not important levels. They anticipate they will have importance also in the future.
As you see, emotions play a role even in trading which could be perceived as just a technical task. It is really beneficial to know what the market is thinking. You should practice reading the market sentiment as well as observing your own emotions in the Olymp Trade demo account. This is just an excellent place to do that as it provides a risk-free environment. This way you can experiment with different scenarios and learn to enter trades at the right moment.
Enjoy trading and control your emotions!
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