Navigating the stock market can be tricky, especially with so many different strategies and technical terms. However, two key concepts—support and resistance—can help you make better trading decisions.
The market moves in trends, which means prices generally follow a certain pattern over time. Technical analysts use various methods to spot these trends, and understanding support and resistance is a core part of that. These levels are crucial when analyzing whether the market is trending upwards, sideways, or downwards.
To make smart trading decisions, it’s important to know support and resistance levels. These levels help you understand price movements and can guide you on the best times to buy or sell.
In this article, we’ll explain what support and resistance levels are in the stock market, how technical analysts identify them, and how they can help you decide when to enter or exit a trade.
What is a Support Level in the Stock Market?
In simple terms, a support level is a price point where a stock’s decline stops and may even start to rise again. This happens when the buying pressure from investors (known as bulls) becomes stronger than the selling pressure from those looking to sell (known as bears). When both sides of the market (buyers and sellers) balance out, the stock’s price stops falling, and that price point is considered the support level.
You can think of the support level as a “price floor” for the stock, which means that prices typically won’t fall below this level for some time. When the price reaches this point, it attracts more buyers who believe the stock is undervalued, creating enough demand to prevent further declines.
Key Points to Understand About Support Levels:
- Demand vs. Supply: At the support level, demand (the number of buyers) is greater than the supply (the number of sellers), which causes the price to stop falling. Essentially, buyers are stepping in to purchase the stock, preventing the price from dropping further.
- Emotional Market Reactions: Support zones are often seen as emotional points on a price chart, where market participants have reacted strongly in the past. If a stock’s price has previously stopped falling and reversed at a certain level, traders often consider this a potential support level.
- Breaks Below Support: If the stock price breaks below the support level, it can be a sign of a larger price decline. This is why a break below support is considered a negative signal for a stock.
- Traders’ Behavior: Traders will often wait for the stock to reach the support level again before buying, since it’s seen as a potential opportunity to purchase the stock at a “discounted” price.
How Support Levels Work:
- Market Psychology: When traders notice a stock repeatedly bouncing back at a certain price level, they start to believe that price is a good entry point. This belief leads to more buying, which in turn supports the price from falling further.
- Example: Imagine a stock is trading at ₹100, but every time it falls to ₹90, it bounces back up. Traders will start seeing ₹90 as a support level. If the stock approaches ₹90 again, many might expect it to rise once more.
In conclusion, support levels are important because they represent a price point where the stock tends to find stability. Traders watch these levels closely, especially during a downtrend, to identify potential buying opportunities.
Also Read: 10 reasons why prices move up and down in the stock market
What is a Resistance Level in the Stock Market?
A resistance level is the price point at which a stock’s upward movement slows down or stops. This happens when selling pressure becomes stronger than buying pressure, preventing the stock price from rising any further. When the price reaches this level, more sellers enter the market, overpowering the buyers and causing the stock to either retreat or stay within a narrow price range.
Key Points to Understand About Resistance Levels:
- Supply vs. Demand: At the resistance level, the number of sellers (supply) exceeds the number of buyers (demand). This causes the stock price to either halt or reverse, as the selling pressure outweighs the buying interest.
- Market Psychology: When traders see the stock reaching a resistance level, they may decide to sell and take profits. This selling activity prevents the price from rising further. The resistance level acts like a barrier that the stock price struggles to break through.
- Break Above Resistance: If a stock manages to break through the resistance level, it can lead to further price increases. In many cases, the resistance level that was broken will then turn into a new support level, as traders now see it as a good buying opportunity.
- Key Charts and Analysis: Chartists or technical analysts carefully study price charts to understand how stocks behave when they reach support and resistance levels. This analysis helps traders predict whether the price will continue rising, fall, or reverse when it approaches these levels.
- Resistance in an Uptrend: During an uptrend, the stock price might rise to a certain point but may struggle to go higher due to the selling pressure at resistance levels.
How Resistance Levels Work:
- Market Psychology: When a stock approaches a resistance level, traders see this as an opportunity to sell. This increased selling activity can stop the stock from rising any further.
- Example: Imagine a stock rises to ₹150, but each time it reaches ₹150, it struggles to go beyond that point. Traders will identify ₹150 as the resistance level, and they may expect the stock to face challenges if it approaches this price again.
In summary, a resistance level is a price point where the selling pressure outweighs the buying pressure, causing the stock price to either retreat or move sideways. Traders closely watch these levels to understand potential turning points and to make informed decisions on when to buy or sell.
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.
The Dynamic Relationship Between Support and Resistance
One of the fascinating aspects of support and resistance is their ability to switch roles. When a support level is breached, it can become a new resistance level. Conversely, when resistance is broken, it may turn into support.
If a stock falls below the support level of ₹90, that level may become resistance on any subsequent attempts to rise back above it. Similarly, if the stock breaks above a resistance level of ₹150, this new level might act as support if the stock later retraces.
Key Points to Remember
- Timeframes Matter: Support and resistance levels can be identified across different time frames—intraday, daily, weekly, or monthly charts. The significance may vary based on how long the time frame is.
- Not Exact Science: Prices may not always behave exactly at these levels. Therefore, traders often view support and resistance as zones rather than fixed points.
- Strength Diminishes Over Time: If a price level is tested frequently, its effectiveness can weaken. For instance, if a stock hits a resistance level multiple times without breaking through, it may eventually fall below that level.
What Happens When Support and Resistance Levels Are Broken by the Market?
When the price moves below the support zone, it signals a bearish trend, meaning the price could continue to fall. Conversely, if the price moves above the resistance zone, it signals a bullish trend, suggesting the price could keep rising.
The more often these support or resistance levels are tested, the stronger the signal becomes. If the price finally breaks through these zones, the bullish or bearish signal becomes more significant, as it indicates a potential shift in market direction.
Support and resistance are crucial in understanding price action in the market. A trend is driven by the actions of buyers and sellers.
When buyers are eager to push prices higher to meet their demand, stock prices rise and often break through resistance levels, leading to a bullish trend.
On the other hand, if sellers become worried about market conditions, they may decide to sell at lower prices, causing the price to fall and break through support levels, leading to a bearish trend. In both cases, the price movements depend on the balance between buying and selling pressure.
Support and resistance can be thought of as a floor and ceiling for stock prices.
- Support is like a floor, where prices tend to stop falling and may start rising again.
- Resistance is like a ceiling, where prices tend to stop rising and may start to fall.
These levels are key elements in technical analysis and form the foundation of price action in all financial markets.
At the support level, traders expect increased demand for a stock, meaning more people will want to buy, which can push the price up. At the resistance level, traders expect an increase in supply, meaning more people will want to sell, which can push the price down.
Traders pay close attention to these levels because they help predict price movements, and decisions are often made based on whether prices are approaching or breaking through these levels.
In the image above, prices reach a low at point X while falling and then start to rise. The next time the price falls, it stops again at point X. This makes point X a support area, where prices temporarily halted. Eventually, the price breaks below this support level at point X and continues to fall further.
When support becomes resistance
Support and resistance levels are terms used to describe the high and low points on a stock chart. These levels show where the price of a stock tends to stop moving up or down.
- Support is the price point where a stock usually stops falling because buyers become more active and start buying.
- Resistance is the price point where a stock tends to stop rising because sellers become more active and start selling.
At these levels, the forces of buying and selling are balanced, meaning neither side is stronger, and the price struggles to move past these points.
At this point, something needs to happen to change the situation, whether it’s a shift in opinion from either the buyers or sellers. This change can come from factors like new news, lawsuits, changes in management, financial problems, or anything else that could affect the business.
Momentum builds as the price moves, until it reaches a point where there is no longer excess supply or demand, causing the price to stabilize.
Traders believe that support is a level where stock prices tend to stop falling and find support. At this point, the stock is more likely to bounce back up rather than continue falling through the support level.
However, if the stock breaks through a support level, it will continue to fall until it reaches the next support level. In this case, the support level that was broken will now act as a resistance level, and the price will struggle to move back above it until the stock reaches the next support level and potentially bounces back.
Similarly, resistance is a level where stock prices tend to stop rising and face resistance. At this point, the stock is more likely to reverse and move down, rather than break through the resistance.
If the stock keeps rising and breaks through the resistance level, it will likely continue to rise until it hits another resistance level. In this case, the first resistance level becomes a new support level, and stock prices may eventually fall back to that level before bouncing back up again.
When the price breaks through support or resistance levels, it suggests that the price will continue moving in the same direction, signaling a change in the market trend.
Because of this, traders closely monitor price movements when the stock approaches support or resistance levels. They watch to see if the price respects these levels or breaks through them. Based on how the price reacts, most traders decide whether to buy or sell the stock.
Long-term traders and investors often take positions when a stock is approaching a key support level. They believe the price will bounce back at this level. However, if the stock breaks through this support level, these traders may start to panic.
If the stock price later rises back to the support level that was broken, most of these traders are likely to exit their positions, either breaking even or with a small loss, to avoid further risk.
If most traders begin selling when the stock breaks through a support level, the selling pressure causes the price to continue falling, turning that broken support into a new resistance level.
As the price approaches this new resistance level, traders may see it as an opportunity to take a short position, expecting the stock to continue its downward trend.
However, if traders believe the price will rise above this new resistance level (which was once the support level), the selling pressure from those holding short positions at this level may reinforce it as a new resistance, preventing the price from moving higher.
On the way up, support reverses its role and acts as a resistance.
In the diagram above, after the price breaks through point X, it stops at point Y. Then, after breaking point Y, the price continues down and eventually stops at point Z, which becomes a new support level.
As the price moves back up, it reaches point Y again. Now, point Y, which was previously a support level, acts as resistance on the way up. This shows how support and resistance levels can switch roles when the price breaks through them.
When Resistance Becomes Support
Sometimes, the price of a stock may break through a resistance level. When this happens, that broken resistance level is often considered a new support level.
At the key resistance level, most traders take short positions, expecting the price to fall. However, when the stock breaks through the resistance level and rises, traders who haven’t closed their short positions start to panic.
If the price then drops back down to the level where it broke the resistance, these traders try to exit their positions, either breaking even or with a small loss. To exit, they need to buy back the stock at the current level. This buying pressure causes the stock price to rise again, turning the previously broken resistance level into a new support level.
Other traders who missed the earlier breakout may now see this as a chance to buy in, adding more buying pressure. As a result, the stock price continues to rise, confirming the broken resistance level as a new support level.
A sideways price movement between the support and resistance levels is called a trading range.
Traders draw trend lines based on these support and resistance levels, known as the support floor and resistance ceiling. When the market moves sideways within these lines, traders often buy near the support level and sell near the resistance level. Some traders, however, may wait for a breakout to enter the market. This shows how market activity reacts within this support and resistance zone.
The diagram below illustrates how resistance can act as support on the way down.
In the diagram above, when the price breaks through the resistance level at point Y, it is temporarily halted at resistance X, which had previously acted as a support level on the way down. After breaking through X, the price then comes back and finds support again at point X.
Therefore, both X and Y act as support on the way down and as resistance on the way up.
Traders carefully monitor all previous highs and lows to see how the price reacts at these levels. These points are important for predicting potential temporary reversals in the market.
How to Identify Support and Resistance Levels
Identifying support and resistance levels is a crucial skill for any trader. Here’s a detailed process to do so:
- Trendlines: Trendlines help visualize support and resistance by connecting the highs (in a downtrend) or lows (in an uptrend) of a stock’s price movements. Connect the peaks to create a descending trendline that acts as resistance. Connect the troughs to form an ascending trendline that serves as support.
- Previous Highs and Lows: Traders often look at past highs and lows because they serve as psychological barriers. If a stock previously reached a certain high, it might struggle to surpass that level again, and vice versa for lows.
- Moving Averages: Moving averages, calculated from a stock’s closing prices over a specific period, can act as effective support and resistance levels. Common moving averages include: Short-Term: 20-day or 50-day moving averages. Long-Term: 100-day or 200-day moving averages. Traders often use these averages to gauge where the stock price might find support or resistance.
- Round Numbers: Psychological levels, often round numbers like ₹100 or ₹200, can also influence trading behavior. Stocks often face significant buying or selling pressure around these figures, as many traders set their buy or sell orders at these levels.
Constructing Support and Resistance Levels: A Step-by-Step Guide
Here’s how to construct support and resistance levels effectively:
- Load Data Points: For short-term analysis use 3-6 months of price data for short-term support and resistance levels. For long-term analysis use 12-18 months of data for long-term levels. The more data points you have, the better you can identify significant levels.
- Identify Price Action Zones: Look for points where the price hesitated after significant upward or downward movements. These zones indicate potential support or resistance levels.
- Align Price Action Zones: Check for at least three price action zones that occur at similar price levels and are spaced apart in time. This repetition helps confirm the strength of the support or resistance level.
- Draw a Horizontal Line: Connect the identified price action zones with a horizontal line. Determine whether it is a support or resistance level based on its position relative to the current market price. Example: If you identify a horizontal line at ₹429 and the current price is ₹442.5, then ₹429 is a support level.
Using Support and Resistance in Trading
Understanding how to use support and resistance levels can enhance your trading strategy. Here’s a practical example:
Trade Setup Example
Imagine a stock currently trading at ₹206.75 with resistance identified at ₹215:
- Entry Price: You decide to enter the trade at ₹206.
- Stop Loss: Set your stop loss at ₹202 to limit potential losses if the price drops below support.
- Target Price: You anticipate reaching the resistance level of ₹215.
Conversely, if the same stock trades at ₹442.5 with support identified at ₹435:
- Entry Price: You may choose to enter at ₹442.
- Stop Loss: Set your stop loss at ₹446.
- Target Price: Your target would be ₹435, expecting the price to bounce back.
Important Considerations
While support and resistance levels provide valuable insights, they are not foolproof. Several external factors can influence stock prices and lead to unexpected movements:
- Market News: Company announcements, earnings reports, and economic indicators can drastically affect prices.
- Geopolitical Events: Political instability or international events can create volatility in stock prices.
- Stock-Specific News: Events related to a specific company (like a new product launch or legal issues) can disrupt expected support or resistance levels.
Building a Trading Checklist
Creating a checklist can help ensure you make well-informed trading decisions. Here are two foundational points to consider:
- Recognizable Candlestick Pattern: The stock should exhibit a clear candlestick formation, indicating a potential reversal.
- Support and Resistance Confirmation: Ensure that your stop loss aligns with the identified support (for long positions) or resistance (for short positions).
By mastering the concepts of support and resistance, you’ll be better equipped to navigate the stock market, make informed decisions, and enhance your trading strategies.
