Support and resistance

Support and resistance are key concepts in technical analysis, serving as critical tools for traders to predict potential price reversals and make informed trading decisions. In essence, they help traders identify price levels at which a stock tends to reverse its direction, either rising or falling.

What are support and resistance levels?

In the simplest terms, support refers to a price level where a stock tends to stop falling and bounce back upwards. It’s the price at which buyers are willing to step in and purchase, preventing the stock from declining further. Resistance, on the other hand, is the level where a stock typically stops rising and starts to decline. It’s where sellers are more inclined to sell, preventing further upward movement.

These price points are crucial because they can offer traders the confidence to try and anticipate stock price movements. This is on the simple premise that if a stock has reversed direction at a specific price point in the past, there’s a good chance it could do so again when it reaches the same level in the future.

Support

Resistance

Support and resistance in action

When a stock is on an upward trajectory and hits a resistance level, it signals that the stock has reached a price that no one is willing to pay more for, at least temporarily. Selling pressure increases, pushing the price down. Conversely, a support level is where a stock’s price becomes attractive to buyers, halting its downward momentum and driving it back up.

For example, in the above chart, a clear resistance level was observed around the 6,185 mark. Every time the index hit this price, it reversed and moved downward.

Using support and resistance to plan trades

Understanding these levels provides traders with key entry and exit points. If you are looking to place a bullish trade, resistance can act as a profit target. When a stock approaches its resistance level, it may signal that it’s time to sell and lock in a profit. On the other hand, if you are looking to place a bearish trade, resistance acts as a point where they might want to consider entering a trade, expecting the price to reverse and decline.

The break of a resistance level, however, can signal further price gains. When a stock breaks through its resistance, it suggests strong buying momentum, and traders often see this as a sign to enter bullish trades, expecting the stock to continue climbing.

Support levels work in the opposite way. If a stock reaches a support level and bounces back, it can provide a good opportunity for a bullish trade, as the stock is likely to rise. If a support level breaks, however, it might indicate further losses, signaling to bearish traders that it’s time to enter short positions or exit their bullish trades.

Support and resistance aren’t always exact

One of the key takeaways for traders is that support and resistance levels are not always precise. While it’s tempting to try and pinpoint exact price points, technical analysis involves more art than science. A resistance level might be broken by a few points before the price reverses, or support might slightly undershoot or overshoot its previous levels. As such, it’s important to treat these levels as zones rather than exact numbers.

Multiple touch points are key

It’s also critical to identify “key” support and resistance levels. These are price levels where the stock or index has reversed multiple times, providing a stronger signal of future reversals. If a stock has only touched a support or resistance level once, it may not be as reliable. However, if it has reversed three or four times at the same level, that’s a much stronger indication that the stock is likely to do the same in the future.

Final notes

Support and resistance are essential tools for any trader engaged in technical analysis. These levels help traders identify potential reversal points, guiding them in making better-informed decisions about when to enter or exit trades. While they are not foolproof, and no one can predict the market with absolute certainty, these concepts can significantly improve a trader’s chances of success when combined with other technical analysis techniques.

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