Market moves in trends. Technical analysts use different techniques to identify the existence of such trends. Along with the up and down trend, support and resistance are at the very core to technical analysis. If you want to understand how and why price moves up and down, then we suggest you to 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 take your buying and selling decision. Before getting into all these, let us understand how price in stock moves.
The most basic tendency of traders is to buy a stock at a price level that they consider is very low and to sell a stock at a price that they consider is relatively high. When the majority of traders believe that price is relatively low, buying pressure overtakes the selling pressure and the price generally goes up. Likewise, when a majority of traders believe that a stock is relatively high, selling pressure overtakes buying pressure and the price generally goes down.
Traders have a basic tendency to buy stocks at a relatively low price and sell at a price that is considered to be relatively high. Low and high levels are determined based on what traders consider it.
When traders think that a certain price level is relatively low in comparison to the actual valuation, buying pressure often results and the price goes up. Conversely, when the majority of traders think that market price is too high in comparison to actual value, selling pressure often results and the share prices go down.
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 a rally.
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.
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.
In the market, support and resistance levels are touched many times due to the aggressiveness of bulls and bears.
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 down or up. 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, lawsuit, 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 price 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 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.
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. Likewise, when the support level is broken by a stock, it’s considered as a new resistance 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 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.