Support and resistance levels are used in technical analysis to predict future price movements. They are also useful for predicting whether a stock will rise or fall over the coming period of time.
Support and Resistance lines can be your entry and exit levels for a long trade and vice versa for short trade. Moreover, prior knowledge of Support and Resistance brings much needed discipline in trading. Being disciplined is an important step for you to become a successful trader.
When you are aware of these levels, you know when to take profits in case of profitable trade and to exit the loosing trade when your stop-loss gets triggered. These levels are formed as a result of popular notion of Technical Analysis –
” History Repeats Itself “
Let us understand what a Support and Resistance is and how they are important for your trading plan!
What Are Support & Resistance Levels?
A support level is a price level seen on technical charts from where the price has been moving up recently after witnessing a decline. If the price breaks below the support level, then there is a good chance that the price will continue falling.
On the other hand, a resistance level is a price levels from where the price is currently moving down after a rise. If the price breaks above the resistance level, then there is an increased likelihood that the price will start rising again.
Support is a price level which corresponds to the demand of the security in the market. So it is the price level at which there are lots of buyers to buy that security.
A stock falling to lower levels stops at a price levels which may reflect its fair value at that time and starts rising again. When the stock again falls after rising, it tends to stop at the price level where it stopped previously and buyers start emerging in anticipation of price rise again.
When the buyers outnumber the sellers, price stops falling and either consolidates there or rebounds, thus confirming the Support for that security.
More the number of times stock rebounds from that price level, more strong the Support becomes. These levels remain in the memory of markets, so even if the stock visits that level after months or years have passed, that levels are expected to provide Support to the falling stock.
It is not that every time stock visits that levels, it will bounce back.It may or may not. If the selling pressure is too high like in situations of weak sentiment or panic, these support levels give away and the stock falls to lower price levels after piercing the Support.
Break down from the Support becomes more significant when it happens with high (more than normal average) volumes.
Usually the support line are drawn straight horizontal lines on the charts of the security or stock. A rising Trend line made by joining the lowest points in a particular time period also act as Support and can be taken into consideration while starting a trade.
Resistance is the price levels of the security or a stock which corresponds to the supply of that stock in market. It is opposite to Support.
It is the price level where sellers outnumber the buyers in the market. A stock which is rising, may stop at the Resistance line and retrace back to lower level.
Whenever the stock will rise towards Resistance line, sellers will start emerging, stalling the price rise. More the number of times stock retraces from Resistance, more strong the Resistance.
Whenever the momentum of price rise is strong in the stock and buyer are more aggressive than the sellers, stock will break above the Resistance line after piercing it and enters new territory which becomes new trading level for it. As in case of Support, a falling Trend line made by joining the highest points is also expected to provide good Resistance.
Why Do They Matter?
It’s important to understand how support and resistance work because they can help you make better decisions when trading stocks. They provide us our stop loss prices and target prices for trading. Knowing these levels is very important for profitable trading whether you are in intraday trading or positional trading.
A support level is where prices stop falling and start rising again. This means that when prices reach a support level, they will begin to rise.
Conversely, a resistance level is where prices stop rising and start falling again. This means that whenever prices reach a resistance level, they will begin falling.
When Should I Use Them?
A support level is where the price has been moving up consistently for a while. If the stock market is currently at $100 per share, then the stock will likely continue to rise until it reaches $110 per share. This is called “support” because the price has been rising steadily and is now expected to keep going higher.
A resistance level is where the price is falling consistently. If the stock market was at $90 per share, then the price would likely fall to $80 per share. This is known as “resistance” because the price has fallen steadily and is now expected not to go back up again.
How to Find Support and Resistance Level?
There are several ways to find support and resistance levels. One easy way is to use an online charting program such as Yahoo! Finance. Another option is to use a free app called Stocksight. Both programs allow you to see charts with different time periods and compare them side by side.
How Do I Know Which Ones To Buy Or Sell At?
If you’re new to stock market investing, you might not understand how support and resistance work. Let’s take a closer look at both concepts.
How To Trade Support and Resistance
It is important to learn how to trade support and resistance after you are able to identify them. Support and resistance on charts give you your target price and stop loss prices for a trade.
Importance of Support
If a falling stock takes support at the Support line, traders may consider buying the stock in anticipation of price appreciation. On the other hand, if a stock breaks important Support levels, traders can short sell the stock and go short.
Your tendency should be to buy a stock which is trading above support line. Look to buy it as near to support line as possible. This keeps your stop loss price near the buying price and consequently the risk is small.
Once a support line is pierced on the downside, then you should avoid buying the stock.
Importance of Resistance
A trader who is long in trade should consider taking profit when stock reaches near the Resistance levels. You can also short sell or go short at the Resistance line. Remember, shorting should be done only below Resistance line.
It is worth mentioning that after breakout from the Resistance line, this line becomes the Support for the stock and in case of breakdown from the Support line, this line becomes the new Resistance line for the stock. So it can be traded accordingly by the traders.