Two of the most heard terms from the domain of technical analysis is Support and Resistance. Both of these represent the key junctures at which the market forces of demand and supply meet. The prices are affected by supply or demand in the financial markets. When we say the market is bearish, it means that the supply, (number of sellers is more). Contrary to this, when there is more demand, i.e., number of buyers than sellers, then the market is termed as bullish.
So what do we mean by Support?
It is a price level where the demand strong and has the potential of preventing the price to fall further. As per the technical analysis, the moment the price starts declining towards estimated support levels; it gets cheaper and attracts more buyers to purchase the stock. The moment the price touches the support level, analysts believe demand overpowers supply and restricts a further dip in prices.
There is every possibility that the support levels will be broken and the prices will come down stronger. This momentum depicts the bearish phase and indicates that more sellers are willing to sell the stock or no such element can attract fresh buyers. Once a support level gets broken, it leads to the establishment of a new lower level.
How is support speculated?
Support of any security is below its current market price. However, there may be a situation where a stock is trading around the support level. Technical analysis used for forecasting of price movements and may not always be bang on. Hence, it is just a speculation that determines the support levels based on certain parameters and market sentiments. Most people believe that the support level will not be crossed if the stock has closed 1/8 beneath the speculated support levels.
And what does Resistance mean?
The concept of resistance is similar to support with a slight difference. It is a strong price level strong that prevents the price of a stock to rise further. As per analysts, with advancement towards resistance, more sellers become attracted to sell while the number of people willing to buy the stock starts decreasing. The moment the price touches the resistance level, there is every likelihood that supply will overpower the demand preventing the price from rising further.
The moment price reaches a resistance level, there is a chance that supply overcomes demand and hence prevents the price from rising above the resistance. If a stock breaches the resistance and reaches a new break above the speculated levels, analysts say bulls won over bears.
How is resistance established?
The resistance level is above its current market price, and there is every possibility that the security is trading near those levels. Like support, if the stock closes 1/8 over the resistance level, it reduces the chances of breaking it.
Methods of Establishing Support and Resistance
The concepts of support and resistance are exactly opposite but have several similar characteristics.
Highs and Lows
It is possible to establish the support levels based on its previous reaction lows. On the other hand, its previous reaction highs can help in establishing resistance.
Support is equal to the resistance
One concept of analysis projects that resistance may turn into support or vice versa. It is a situation where the price goes below the support level and then turn into the next resistance for the stock. Similarly, the moment a price breaks the resistance; this previously established resistance becomes the next support level for the stock.
Trading Range
The trading range plays a crucial role when it comes to establishing support and resistance. They serve as the turning point or the continuation pattern. This range is the period where prices fluctuate within the relatively strict/compact range. It eventually indicates that forces of both supply and demand remain balanced. The moment a price goes beyond a trading range, the upward or the downward direction, it indicates the winner. For example, any break above the range indicates bearish markets, i.e. bulls have won, and demand has increased. On the other hand, any break below a trading range indicates a bearish scenario where the supply has increased.
Support & Resistance Zones
As mentioned above, technical analysis isn’t always spot on but can help in establishing support & resistance zones. Every security has unique characteristics and upon analyzing the intricacies become evident. Depending on the scenario, on occasions levels work well while sometimes, the zones offer a better picture. The compact/limited the range, more exact is the level. In case a trading range has been there for two months, a price range comparatively tight. It indicates that exact levels are best to consider. However, if the trading range has been the same for several months, a price range is comparatively larger. It is preferable to consider support and resistance zones.
Concluding Remarks
The process of identifying the right support and resistance level serves as the key ingredient of useful technical analysis. Although, it is not easy to establish the support and resistance level, staying informed enhances the forecasting and analytical ability. In case, the security approaches any important support level; it offers an indication of staying alert and possible sentiments of the market. Similarly, with the resistance level being close to the current price levels, it offers a clear indication of an increase in selling pressure.