Market moves in trends. Technical analysts use different techniques to identify the existence of such trends. Along with the up-trend, sideways and downtrend, support and resistance levels are at the very core to technical analysis.
Understanding support and resistance is essential for understanding price trends to help you know when to enter and exit a trade.
If you want to understand how and why price moves up and down, then we suggest you understand these levels.
In this article, we will understand what is the support and resistance level in the stock market and how technical analysts find these levels. You will also know how it helps to make your buying and selling decision.
What is support level
When market price has gone up or is at a point which is higher than the actual price of the stock, aggressiveness of bears falls and the aggressiveness of bulls rises, resulting in the stock price to fall.
At a point, when aggressiveness of bears and bulls balance, prices stop falling and support level of the stock is established.
Support is a level where buying pressure exceeds the selling pressure and a decline is halted.Some market participants consider support as price floor and resistance as price ceiling.
In the stock market, support and resistance levels are touched many times due to the aggressiveness of bulls and bears.
At support, demand has increased to a point where it balances out the supply. Similarly, at resistance, supply has increased to a point where it balances out demand.
Support zone is the price level at which a stock’s price has stopped falling in the past and has either moved sideways or reversed its direction. At this level, selling pressure has dropped off and demand for the stock was strong enough to prevent the price from dropping further. These zones in price charts are marked by traders as emotional points indicating how market participants reacted to these levels in the past.
In other words, support is a level where demand exceeds supply and prevents the price from falling or buyers overcome sellers.
A break below the support area has very negative implications for the price of the stock.
If market participants have marked a level where prices have earlier stopped falling and turned up from that level, then they are most likely to wait for prices to come to that level again to press a buy button.
Also Read: 10 reasons why prices move up and down in the stock market
What is resistance level
Market price of a stock is known as the fair value at which the bulls and bears have agreed upon to trade.
If bulls think that the market price is lower than the actual price, they will attempt to buy. Therefore, the demand of the stock will go up, in turn, the price will rise. At a certain point, aggressiveness of bulls and bears will balance and the price of the stock will settle for a while at that point, that level is known as resistance.
Resistance is a level where selling pressure exceeds the buying pressure to halt an up trend.
Resistance is the price at which selling pressure is strong enough to prevent a stock from rising further.
In other words, supply exceeds demand, and buying pressure is not strong enough to break the resistance level. At this point, more sellers might enter the market and prevent the stock from going higher. In other words, resistance is a level where sellers overpower buyers.
Chartists analyse charts to determine what happens to a stock when it reaches key support and resistance levels. The key point is determining how the stock or market will react when it approaches support or resistance levels. Will it break through, or will it reverse?
When resistance is broken, that level often turns into support. Conversely, when support is broken, it frequently becomes the new resistance level.
Importance of volume at support and resistance levels
In general, buyers push the stock up and sellers push the stock down. Volume with price action can confirm who is responsible for rise or fall in stock. Therefore, it’s always essential to read volume in conjunction with price.
Volume, which is usually displayed at the bottom of the stock chart, is the number of shares traded over a given period. To confirm a bullish breakout, traders want to see if the underlying security moves higher on higher volume. This is a positive sign for the bulls.
On the other hand, if a stock is falling on higher volume, then it signals the start of a short-term correction.
Volume lets you know the liquidity of a stock. Liquid stocks allow you to get filled quickly. Illiquid stocks are very difficult to sell at a competitive price. Intraday traders prefer to trade in liquid stocks to get in and out quickly.
What happens when support and resistance levels are broken by market?
A move below the support zone or above the resistance zone is considered as a bearish and bullish signal respectively.
The more time these support or resistance levels are tested, the more important the bullish signal that is given if these zones are eventually broken.
Support and resistance form a key role in price action.
A trend is determined based on the enthusiasm of buyers as compared to sellers, or vice versa.
If buyers are aggressively bidding higher prices to satisfy their purchasing demand, then stock prices will go higher by breaking most of the resistance levels.
On the other hand, if sellers are fearful of the market condition, they will be willing to liquidate their position at lower prices, due to which the general market price level will fall by breaking most of the support levels.
Support and resistance are like a floor and a ceiling.
In general, support can be considered as a floor for price action, while resistance can be considered a ceiling for price action. Prices tend to react to these levels.
Along with the concept of trend, support and resistance are considered as a core to the technical analysis.
These two form the essential structure of price action in all financial markets.
Support is considered as a temporary price floor and resistance is considered a temporary price ceiling.
At support level, traders expect a considerable increase in the demand for a stock, or buying. Likewise, at resistance level, they expect a considerable increase in the supply, or selling.
These levels are considered as an important element in price action as traders remember these specific price levels and will base their trading decisions on these levels.
In the above picture, prices find a bottom at point X while falling and then move up. Next time when it falls, it stops again at point X, therefore point X is considered as a support area where prices temporarily stopped. At last price breaks the support area at point X to move lower.
When support becomes resistance
Support and resistance levels are two terms that define the peaks and troughs on the chart. This means, Support and Resistance are levels at which the price of a stock stops going up or down .
It’s the point at which the aggressiveness of bulls and bears balance. This means they show equal aggressiveness.
At this point something has to occur to change, at least one side’s opinion, it can be fresh news, lawsuits, change in management, financial issues and any other things which can impact the business.
Momentum builds until the price reaches levels that exhaust excess supply or excess demand.
Traders believe that support is a level where stock prices find support as it falls. From this point, the stock’s price will most likely bounce back rather than break through it.
However, if the stock breaks through a support level, then it will continue falling until the next support level meets. In this case, the first support level which the stock has broken, becomes the resistance level until it reaches the second support level and bounces back to it again.
Likewise, resistance is a level where stock price tends to find resistance as it rises. From this point, stock prices will most likely come down instead of a breakout.
If the stock continues rising instead of falling from the resistance level, then it most likely will continue rising until it finds another resistance level. In this case, the first resistance level becomes the support level until stock prices have fallen back to that level.
When price violates support and resistance levels, it indicates that price will move further in the same direction as the market trend has changed.
Therefore, whenever price nears the support or resistance levels, traders closely watch the price action to know whether the level has been respected or violated. Based on how prices reacted at these levels, the majority of traders take decisions of buying or selling the stock.
Long term traders/investors take their long term position when stock is about to hit a key support level. When the stock breaks the key support level, these traders begin to panic.
If the price of the stock rises back to the support level which was broken then, the majority of these traders are happy to get out of it either at breakeven or with a small loss.
If the majority of traders start selling at the breakdown level, then due to the selling pressure, the price of the stock moves down by confirming this new level as resistance level.
When price is about to touch the new resistance level, traders take this opportunity to take a short position with expectations that the stock will continue its downward trend.
If these traders think that price will rise above the new resistance level/old support level, the selling pressure depending on the position taken by traders places at this level by contributing it as a new resistance level.
On the way up, support reverses its role and acts as a resistance.
In our above diagram, prices after breaking point X, stopped at point Y. After breaking point Y, price stopped at point Z, which proves to be a support level. Then prices moved back and stopped at point Y, which was our earlier support now acting as a resistance on the way up.
When resistance is considered as support
There can be instances where the market price of a stock breaks the resistance level. In such a situation, the broken resistance level is considered as a new support level.
At the key resistance level, majority traders take short positions. When the stock breaks the resistance level to the upside, these market participants who did not close their position, begin to panic.
If market price comes down to the level where it broke, then these traders try to get out of their position either with a breakeven or at a smaller loss.
To get out, they need to buy back stocks at the current level. This buying pressure moves the stock price upward due to which the resistance level becomes the support level.
Certain other traders who missed the earlier breakout are now tempted to take this opportunity to get into the stock. Depending on the buying pressure, stock again moves upward by confirming the earlier resistance level as a new support level.
Sideways price action between the support and resistance level is called a trading range.
Traders draw trend lines based on the support and resistance levels, which is known as the support floor and a resistance ceiling level.
When the market moves sideways within these two lines, known as the trading range, few traders take this opportunity to buy near the support level and sell near the resistance level. Few other traders wait for a breakout to get into the stock. This means market activity reacts around this region or zone.
Below diagram shows how resistance acts as a support on the way down.
In our above diagram, when price breaks the resistance level at point Y, it is temporarily halted at resistance X, which earlier acts as a support on the way down. After breaking point X, price comes back and finds support at point X. Therefore, X and Y are points which act as support on the way down and resistance on the way up.
All previous highs and lows are carefully watched by traders to know how prices react to these levels. These are important places for anticipating a temporary reversal.