What are Support and Resistance Lines?
Support and resistance lines are key points where supply and
demand intersect, acting as thresholds for price movements. A support line is
the level at which a stock's price is unlikely to fall further due to
sufficient demand, potentially reversing a downtrend. Conversely, a resistance
line indicates a price level where supply is strong enough to halt a price
increase, preventing an uptrend. Trend lines can also serve as angled support
and resistance levels.
Support
Support acts as a horizontal floor, where buying interest
overcomes selling pressure. As prices decline toward support, buyers become
more willing to purchase, while sellers hesitate to sell. If the price breaks
below this level, it indicates a loss of bullish sentiment, suggesting sellers
are ready to sell at lower prices. A new support level will need to be
established if this occurs.
Resistance
Resistance functions as a horizontal ceiling, where selling
pressure surpasses buying interest. As prices approach resistance, sellers are
more inclined to sell, while buyers become cautious. A break above resistance
signals a shift in sentiment, indicating that buyers are willing to purchase at
higher prices. If resistance is broken, a new resistance level will need to be
set..
Why do Support and Resistance lines occur?
A stock's price is driven by supply and demand. Bulls buy
when prices are low, while bears sell when prices peak. The market finds
balance when both sides agree on a price. As prices rise, bears become more
aggressive, creating a resistance line where upward movement stalls.
Conversely, as prices decline, the support line forms, marking a point where
demand outweighs supply, leading buyers to step in and sellers to hold. Breaks
through these lines indicate a shift in control: a break above resistance
signals bulls gaining strength, while a break below support shows increased
selling pressure. New support or resistance levels will then emerge.
Support and Resistance Zones:
Support and resistance are often viewed as specific price
levels, such as saying the support for ABC FUTURES is at 4850. However,
thinking of them as exact prices can lead to missed opportunities. In reality,
these levels are better understood as zones. For instance, a resistance level
at Rs 50 encompasses a range around that price—stocks may hit 49.87 or 50.25
and still reflect resistance.
Using price zones instead of fixed levels provides better
trading opportunities. A risk-taking investor might buy near the top of a
support zone, while a cautious investor may wait for the bottom. The speed at
which prices approach a resistance zone affects testing; rapid moves can lead
to higher spikes that don’t precisely hit the target.
Moreover, resistance can become support and vice versa.
After breaking a support level, investors may sell, causing prices to rebound
and turning that level into resistance. Recognizing these dynamics helps
traders make more informed decisions.
Change of Support to Resistance and vice versa:
A key principle of technical analysis is that support can turn into resistance and vice versa. When the price breaks below a support level, that level may become resistance, indicating that supply has outpaced demand. If the price revisits this level, increased supply is likely.
Conversely, when the price rises above a resistance level, it signifies a shift in demand and supply dynamics. This breakout shows that demand has exceeded supply. If the price returns to this level, it may establish new support, reflecting increased buying interest.
Importance of Support & Resistance:
- Market Memory: Technical analysts believe the market has a memory, where support and resistance lines play a crucial role.
- Investor Recall: Investors tend to remember previous price levels, making them significant in trading decisions.
- Rapid Price Changes: When stock prices fluctuate rapidly, buying and selling occur at varied levels, resulting in no clear pattern.
- Narrow Trading Ranges: Prices trading within a narrow range for a prolonged period form specific areas that investors begin to recognize.
- Increased Volume: If prices remain within a range for an extended time, the volume at that level increases, enhancing its importance.
- Significant Levels: The longer a price level holds, the more significant it becomes for technical analysts.
- Target Prices:
Previous support and resistance levels can serve as target or limit prices when
the market moves away from them.
