While Finquity+ went through topics like types of candles, types of chart patterns, etc while sharing the know-how of technical analysis, the readers have long waited for one concept that is always used by technical analysts everywhere. Hence, it is time to address the elephant in the room - Support and Resistance.
Support and Resistance are the two strong pillars of technical analysis. They are the key levels at which forces of supply (sellers) and demand(buyers)meet. This means the number of shares demanded at a particular price is almost the same as the number of shares supplied at the same price level. The support and resistance are also called trendlines since they indicate the direction of the stocks.
Support
Support is a price level where a downtrendcan be expected to pause due to a concentration of demand or buying interest.
In other words, it is a demand zone that absorbs all the sellers after which demand rises sufficiently to stop the prices to decline any further.
Psychology
At support levels, with sufficient demands, the prices stop declining temporarily. Hence, when the prices become low enough, more people wish to buy the stock, increasing the demand significantly. Buyers are more inclined to buy at lower prices and the sellers are less likely to sell at such price resulting in a change in the trend.
By the time prices reach the support level, it is assumed that demand will overcome the supply and price won't fall from that level.
Example
Do prices always respect the support levels?
No, the prices do not always hold the support level true. At times it breaks the support level and goes down further indicating that the bears have been very heavy on the bulls. This indicates that there are a higher number of traders/investors who are willing to sell rather than buy. Once a support level is breached then it has to make new support by making a new low.
Following is an example of stock breaching a support level
Supports are usually a combination of multiple lows in the past at the same level.
Resistance
Resistance, or a resistance level, is the price at which the the price of an asset meets pressure on its way up by the emergence of a growing number of sellers who wish to sell at that price.
Psychology
It is the level which indicates that the sellers grow sufficiently to meet the demand. It is also known as the supply zone which absorbs all the bulls and bears enter the market.
Technically, sellers become more inclined to sell and buyers become less inclined to buy the stocks.
After the prices reach the resistance it is believed that supply overcomes the demand which prevents the stock from rising further.
Example
And you guessed it right, no the prices do not respect the resistance always. It is just the opposite of support, so let's not bore you with the vice versa and waste your time.
Following is an example of stock breaching a resistance level
NOTE: Once the resistance is breached it becomes the support level and vice-versa
Trading Decision Using Support and Resistance
This concept can be better understood with the help of an example from the market.
Support and Resistance levels are particular points of prices on the chart and not a range. For example, for a particular stock Rs.100 can be the level of support or resistance.
However, while studying the chart of security which is highly unpredictable, relying on one particular point to execute your trade is a dumb act.
Let us look at the chart of HDFC Life, The green line on the top (with points 1 and 2) is the resistance line as it formed by 2 major highs in the given trend. Hence, going by the textbook, an investor/trader holding the share should wait for the stock to touch the resistance line. Given the unpredictability of stocks, in reality, the prices may never reach that point and reverse from levels below it. The investor might miss the opportunity to sell.
Technical Analysis has got an answer for this dilemma as well. One cannot rely on a particular point, but one can surely rely on a defined zone of prices where one can execute a trade.
In the chart, at Point 1 a trader has two choices to make:
Either wait for the stock to break-out the resistance level and buy keeping the resistance as stop-loss ( the new support level)
Or, wait for a reversal candle/chart patterns and sell the stock keeping the resistance as the stop-loss.
However, waiting for the price to reach Rs 520 may not be a rational decision to make. However, marking a resistance zone of Rs 515-520 and selling/buying between these points is a wise choice to make.
Similarly, the line below is the support line (with points 3 and 4), and waiting for the prices to reach the support level may lead you to lose a good buying/selling opportunity as the stock may rally before you make a decision.
Hence, at Point 4 a trader again has two options to execute:
Either, buy when there is a reversal candle/ chart pattern from the point and keeping the support level as the stop-loss.
Or, sell once the script breaks the support level keeping support level as the stop-loss (now the new resistance)
Once Again, waiting for the stock to touch Rs 465 may not be rational as well. Marking a support zone between Rs 465 - 470 and making a decision when the stock reaches it should be the go-to option.
In conclusion, Support and Resistance act as major levels for a reversal in trend or a breakout
We hope that we have addressed a topic of everyone's interest, however, there is a lot more to explore and explain. Stay tuned to keep the learning curve going while the world is busy flattening the COVID - 19 curve.
Stay tuned and stay safe!
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