Important concepts in technical analysis are support and resistance. Correctly interpreting price charts requires an understanding of these terminology and how they are applied in practice.
Supply and demand influence market prices. As consumer demand exceeds available goods and services, prices rise.
Supply exceeding demand causes a decline in market value. When demand and supply are equal, prices may fluctuate in a narrow range.
Technical concepts, like many others in technical analysis, can be easily explained and justified in principle, but expertise in their application might require a great deal of experience to achieve.
KEY POINTS
- Support and resistance levels are used by technical analysts to pinpoint areas on a price chart where a halt or reversal of the current trend is more likely to occur.
- Where there is a large amount of buyer interest, a downward trend is said to be supported.
- Where there is an abundance of supply, an upward tendency is met with resistance.
- Market participants rely heavily on their memories of the past and their responses to shifting market conditions in order to predict the direction of future price changes.
- Using trendlines and moving averages, you can see where support and resistance levels are forming on a chart.
Basically, What is Support?
In a downward price trend, supply exceeds demand, leading to falling prices. The more shares drop in price, the more interested individuals on the sidelines will be to buy them.
Slowly rising demand will eventually reach a level where it is equal to supply. There will be no further decrease in costs from here on out. There is help here.
A price level or range on the chart can serve as support. Whatever the case may be, support is a place on a price chart where buyers are eager to step in.
At this point, buyers typically outnumber sellers, halting the price drop and often causing it to turn upwards.
What is Resistance?
To oppose anything is to encounter resistance. More buyers than sellers causes a price increase. If prices continue to rise, eventually sellers will have more buyers than buyers.
There are a number of causes for this phenomenon. It’s possible that market participants have concluded that current prices are too high or have reached their goal.
Maybe at play is investors’ hesitation to open fresh holdings in light of the stock’s high price. Several more explanations are possible.
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When looking at a pricing chart, however, a specialist may easily identify the point at which supply begins to outpace demand. What you’re seeing is an act of defiance. It might be a level or zone, just like support.
When the price reaches a level of previous support or resistance, it will either bounce back away from the level and continue away in its prior direction, or it will violate the price level and continue in its prior direction, until it reaches the next support or resistance level, at which point it will reverse direction.
Some trades are timed on the assumption that price will not break through key support or resistance levels.
Traders can “bet” on the direction of price and instantly determine if they are correct if the price is stopped at or breaks through the support or resistance level.
The position can be closed at a minor loss if the price advances in the incorrect direction (through earlier support or resistance levels). Yet, if the price goes in the right direction (respects previous support or resistance levels), the shift could be rather large.
The Fundamentals
Daily, weekly, and monthly charts all feature support and resistance levels. Support and resistance are also present in more compact time frames that traders use, such as one-minute and five-minute charts.
The significance of support or resistance increases, however, as time period increases. Support and resistance levels can be found by looking back at the chart for instances of considerable consolidation in either the price decrease or the price increase.
Then, as the price comes closer to that level, watch to see if it stalls and/or turns around. As has been mentioned above, seasoned traders often look at previous price activity to determine where support and resistance levels might form again.
Support levels are only estimates, and technical analysis can be wrong if the price falls below them or turns around before reaching the previous support level.
The same holds true for resistance, since price might reverse course before reaching the previous resistance level or even after breaking over it.
It takes some imagination to make sense of these chart patterns. This is why zones can be used to describe support and resistance levels.
These costs aren’t somehow miraculous, either. It’s just that a lot of people in the market are responding on the same data and making trades at about the same prices.
Most seasoned traders have anecdotes of the price of an asset freezing up at a specific threshold. Let’s say Jade held a stock stake from March to November, anticipating a rise in the price of the shares.
Let’s say Jade keeps track of the price and sees that it comes close to breaking above $13081 multiple times over the course of several months but always falls short.
The area around $13081 is seen by market participants as a level of resistance. The next chart illustrates how resistance levels are also seen as a ceiling since they mark the points at which a rally loses steam.
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The inverse of resistance levels is support. The point of equilibrium between buying and selling prices is called “support” on a price chart. What this signifies is that demand has now caught up with supply.
Because of this, the drop in the asset’s price has been halted, indicating that price has reached a price floor. The price floor is depicted by the horizontal line in the following chart.
Four times in the past, as indicated by the blue arrows below the vertical line, the price reached this point. The influx of new buyers at this price point keeps prices from falling even lower. The photo below illustrates a support.
Keep an eye on this space for part 2 on support and resistance fundamentals
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