Understanding Support and Resistance - A Beginner's Guide
Support and resistance are crucial concepts in technical analysis that can help traders identify opportune times to enter and exit trades. This beginner's guide will explain what support and resistance are, how to identify them, and how to incorporate them into your trading strategy.
What is Support and Resistance?
Now we will discuss support and resistance in detail. You can also refer Malayalam video given in last part of this post for more details.
Understanding Price Support Levels
When analyzing a stock's price chart, an important concept to grasp is that of support levels. A support level refers to a price at which enough buyers tend to enter to prevent the stock price from falling below that threshold. It signifies where bullish traders demonstrate that they believe the stock is undervalued or worth accumulating more shares at that given price.
How Support Levels Form
Support levels emerge on stock charts in areas where previous price drops have been met with renewed buying interest. For example, if a stock has fallen to ₹500 in the past and buyers came in heavily enough to reverse the decline at that price, ₹500 becomes a support level. This price area marked a prior turning point where sentiment shifted from bearish to bullish.
As the stock trends lower in the future, traders expect to see similar buyer demand around that support zone. This buying activity then acts as a floor to halt subsequent descents in price. The more times over past price history that a support level holds firm, the stronger that area of support becomes. Technical analysts pay close attention to well-established support for potential long entry points or stop losses on short positions.
Price Bounces Off Support
When a stock does drop to known support during its downward trajectory, several things may happen. Ideal for buyers, the stock will bounce off support like a ball bounces off the floor. This signifies the support effectively held firm and gave bullish traders a second chance to participate as buyers again on the way back up.
Alternatively, the stock may weakly settle around support temporarily before it gives way to more selling. Or the stock blasts right through support with heavy volume reflecting a mass shift to a bearish bias. Analyzing volume and price action around key support zones assists traders enormously in timing entries, stop losses and gains.
Understanding Stock Price Resistance Levels
Resistance is the opposite of support and refers to price areas on a stock chart where selling pressure is strong enough to halt rallies. It represents the ceiling at which bullish traders believe the stock is getting expensive or overbought.
How Resistance Forms
Areas of technical resistance take shape just above prices where previous rallies peaked and then fizzled out. For example, if a stock has risen to ₹550 in the past but then faced a wave of selling that reversed its ascent multiple times, ₹550 becomes a resistance level. Bulls were not willing to buy beyond that price.
As this stock trends higher in the future, traders expect a similar rejection around that zone now serving as resistance. The more times over the stock's price history that a resistance level holds firm, the stronger that area of resistance becomes. Technical analysts closely watch historical resistance points for potential selling entry opportunities or gain-taking exit points on existing long positions.
Price Reaches Resistance
When a stock rallies up to a known area of solid resistance, several things may transpire. Ideally for those holding long positions, the stock will burst right through resistance with heavy buying volume behind it - reflecting bulls have overwhelmed the bears. This signals upside continuation of the uptrend.
Alternatively, the stock may hesitate around resistance temporarily before it gives way to more profit-taking selling. Or the stock gets firmly rejected by key resistance as sellers take control there, signaling a weakening of upside momentum. Analyzing price action dynamics around resistance assists traders enormously in timing both entries and exits.
Identifying Potential Areas of Support and Resistance
Technical traders rely heavily on identifying key support and resistance levels in a stock before entering trades. These supply/demand zones serve as potential reaction points where the stock price may encounter friction and stall or reverse its trajectory. There are several core methods to spot these pivotal areas:
Previous Price Swing Highs and Lows
One of the most straightforward yet effective approaches to identify potential support and resistance involves looking back on the price chart to see where previous rallies peaked and turned lower or sell-offs bottomed out and rebounded higher.
The turning points where the uptrends or downtrends shifted are marked by swing highs and swing lows in the price action. Connecting a series of these swing highs and lows using trendlines makes it clear where future support or resistance may emerge.
For example, if a stock made a lower swing high peak of ₹550 on three separate occasions over the past few months as buyers failed to push it higher, that becomes a significant resistance zone between ₹540-560.
Similarly, if that stock fell to ₹500 a couple times and bounced firmly off that area, then ₹500 may serve as reliable support going forward.
The more times in the stock's price history that it reversed its trajectory around a specific price area reinforces that level's technical relevance for future moves. Thus, reviewing previous swing turns proves enormously useful.
Using Trendlines to Spot Support and Resistance
One of the most common ways traders identify possible future support or resistance levels is by drawing uptrend lines or downtrend lines on the price chart. This involves connecting two or more previous swing highs or swing lows to extend a line into the future.
Uptrend Line Support
An uptrend line connects rising swing lows as the price bounces higher over time. This upward sloping trendline serves as an angle of potential support for pullbacks and dips going forward. Traders expect buying interest to emerge around this rising trendline since previous pullbacks held.
Downtrend Line Resistance
A downtrend line connects falling swing high peaks as the price drops lower over a series of lower highs and lower lows. This downward sloping trendline indicates potential resistance for bounces and rallies. Selling interest is expected around this falling trendline given that's where previous bounces reversed lower from.
Trendline Relevance
The more times that prices react around an established trendline, the stronger that line's technical relevance becomes as future support or resistance. Technical traders routinely identify these key sloping trendlines that may influence upcoming moves and plan trades accordingly based on probabilities. Connecting swing highs and lows remains an invaluable skill in price chart analysis.
Volume Profile Analysis
Volume profile graphs show the trading activity behind price movements over time. Areas along the price axis that saw heavy trading volume in the past often transform into zones of support or resistance during subsequent price swings. Traders can identify highly 'visible' volume-packed levels that may offer clues about significant stages for potential long entries or short covers.
Psychological Milestone Numbers
Traders also routinely consider big, round price milestones like ₹10,000 or ₹15,000 per share as potential areas of support or resistance. They represent psychological thresholds where investor sentiment and trading conviction face tests. For example, it requires incremental buying enthusiasm for prices to confidently push above a major marker like ₹20,000 versus pausing around that level.
How to Trade Using Support and Resistance
Once key levels are identified, traders can make trading decisions based on expected price behaviour at support and resistance:
Going Long at Support
One common tactic involves going long by buying shares or call options when the price drops to retest an area of established price support. The plan would be to close positions for a profit on a subsequent bounce higher off support.
Taking Profits Near Resistance
Conversely, traders with existing long stock or call option positions may trim or unload those holdings as the rising price approaches known overhead resistance. The rationale is that overhead resistance may repel the advance and lead to a pullback.
Initiating Shorts at Resistance
Traders may also look to open short stock or put option positions as the price rallies up towards a clear zone of technical resistance, especially if overhead resistance rejected advances multiple times before. The goal would be closing shorts at a profit on a turn lower off resistance.
Placing Stop Losses Below Support
When holding short positions, savvy traders always ensure to place stop loss orders below defined support levels. This safeguards against unexpected breakouts above support that would lead to losses. The stop loss exit would trigger to close out shorts before that occurs.
Analyzing Price Action
In addition to entering around support/resistance, traders closely analyze price action and volume when prices reach these areas. For example, heavy volume on breakouts above resistance reflect true shifts in supply/demand versus lackluster action. Repeated bounce off support signals robust demand exists there repeatedly. Integrating simple strategies around pivotal zones with detailed price action analysis keeps traders ahead of the pack.
Conclusion
Identifying support and resistance is more art than science. With practice, traders can get better at spotting significant S/R levels. Always use stop losses, and complement S/R analysis with other strategies. Over time, incorporating support and resistance should improve trading outcomes.
To know more, check video shared below from our youtube channel "Share market malayalam by Muhammad Riyas"
Support and resistance part 1 - https://youtu.be/oL2S56HEjCo?si=44Oakm3BIhvg62F9
Check All posts in support and resistance series
Part 2 : Gaps as potential support and resistance
Part 3 : How to draw support and resistance
Part 4 : Dynamic support and resistance
0 Comments