Support and resistance- Technical Analysis
Support and resistance are the major concepts in technical analysis. Support levels are where demand is so strong that it prevents prices from declining any further. Whereas, resistance levels are when supply is so strong that it prevents prices from rising any further.
Because of the psychological importance, round numbers are important to support and resistance levels. Traders often look for round numbers like 10, 20, 50, 100, 1000 etc. as these indicate important turning points where traders are likely to make buy or sell decisions.
Buyers usually buy a large number of stocks when the price starts to decline towards a major round number as it makes it difficult for shares to fall beyond that level. Likewise, sellers sell stock as price moves towards round number peak as it makes it difficult to rise above the upper level. This increased buying and selling pressure make them significant points of support and resistance as well as, major psychological points.
A trendline’s role is known to be reversed and not a vital area of support and resistance when that’s broken. The trendline, however, is expected to be a support level moving forward when a price breaks out from a resistance trendline. An important point is that reversal is required to be an ideal reversal and not false breakout or breakdown.
For example, the abovefigureshows an instance where a resistance level turns out to be a support level prior to returning to a resistance level after a series of breakouts. The strength of trendline as well tends to become greater over time considering the number of rebounds. However, the importance of these role reversals is often misjudged by traders, who eventually fails in realizing the number of times they occur.
Stock will always have both support and resistance level and before breaking out higher or lower, a stock is likely to trade in between them. The breakout is expected to alter the trendline that was broken into the opposite role and a new price channel will be initiated.
Importance of Support and resistance
Support and resistance levels are a crucial aspect of trend analysis as they often help in making trading decisions and also in recognizing the trend and when it is supposed to reverse. These levels also assist in observing and confirming the trends, ongoing as well as upcoming, hence traders involved in the technical analysis should look for these levels. As long as the price remains between two levels, it is supposed to move in the same direction.
However, a break beyond support or resistance does not always imply a reversal. For example, a breakout higher may lead to a bullish trend and vice versa in case of a breakdown below trendline support.
Traders should be well aware of support and resistance levels and as these points are usually classified by volatility, traders should avoid settling orders at these major points. If traders are willing to place an order near these levels, making orders directly at these levels should however be avoided as they are rarely reached. This happens because of the price that never reaches the whole number. Moreover, to exploit on a breakdown or breakout, traders can place short selling around these levels.