Support and Resistance
Support and resistance are points on charts where forces of supply and demand meet. This support and resistance are crucial points for traders to determine market psychology and supply and demand. When the assumed support and resistance lines are broken, market forces of supply and demand also get shifted. This creates new levels of support and resistance.
Support is that place on the chart where the demand is strong enough to stop the price from falling any further. In the picture given above, you can see that each time the market reaches the marked support line, it faces difficulty in coming down. The reason behind this mechanism is that as the price approaches the support line, buyers become active and sellers not wanting to sell. As all these actions happen together, price reacts and jumps towards the upside.
Resistance is the point at which supply is strong enough to stop the price from moving further. In the picture given above, you can see that each time price reaches the resistance line, it is unable to move higher. The reason behind this mechanism is that as the price approaches the resistance, sellers become inclined to sell buyers are not willing to buy. Hence, the price drops significantly.
Making of support and resistance
Let’s take a few examples to clearly understanding the working of support and resistance.
Let’s say some buyers are buying a particular stock at the price of $20. They may be buying because $20 may be acting as support. They buy some more shares when the stock comes back to $20, and now the price moves up and goes to a level of $25. The traders who bought $20 are happy and want to buy more, but not at $25. They decide to buy more once the price comes back down to $20. By buying again and again at $20, they are creating demand at that price.
Let’s take another case. There is a group of investors who are not very committed. They are thinking of buying the stock at $20 but never bought it before. Now that the stock is trading at $25, they regret not buying it. In their mind, they think that if the stock comes back again to $50, they will not make the same mistake and will buy the stock this time. This is another reason for creating demand at that price.
Now the third group of investors bought the stock below $20. They might have bought it for $17. When the stock went to $20, they sold it to make a profit. After that, they watch the stock going to $25, themselves not having the stock. Now, they want to get into long positions and would not mind buying at the same price at which they had sold, i.e. at $20. They changed their stance from sellers to buyers. This creates more demand at that price.
We will now see what in the opposite case of resistance. Consider the three types of above investors. And all of them own the stock at $20. Take yourself as also one of the buyers of the stock. The stock goes to $25, and you don’t sell it. Now it comes back to $20. You must be feeling disgusting. You regret not selling at $25. Imagine it goes back to $25, this time you sell all the shares of the stock you had purchased. So do the other group of investors. Many people try to sell at $25, and stock cannot go past $25. There are at least three types of traders who are willing to sell when it goes back to that price. This creates a lot of supply at that level, which, in turn, means resistance for the price.
These are just a few cases of many such points on charts. If you are an experienced trader, you would have probably been through these scenarios and understand the psychology behind support and resistance points. There are thousands of people going through the same emotions and thought processes as you, every day. This is how technical analysis works in general.
Support and resistance switching sides
A key concept in learning about support and resistance is that when a support or resistance is broken, the two switch roles. If the price breaks a support level, that level becomes new resistance. If the price breaks a resistance level, that level becomes new support. As there are price breaches on either side, it is thought supply and demand have shifted, causing reversing of roles.
Support becoming resistance
Resistance becoming support
Combing other technical analysis tools with support and resistance
Many aspects of technical analysis are built upon the concepts of SR trends. These tend to provide dependable confirming or contradicting signals that every technician can employ to strengthen a belief about the next price movement. You may view trading range as support on the bottom and resistance on top. Looking ahead and attempting to anticipate the movement at those levels is the task of technical analysts.
Support and resistance is not science, and it depends on one’s interpretation. If you study more about support and resistance, you will find many theories which say it is an art of trading. It takes hard work and dedication to trade support and resistance like an expert.