Support and resistance levels can be identified by trend lines (technical analysis). Some traders believe in using pivot point calculations. The more often a support/resistance level is “tested” (touched and bounced off by price), the more significance is given to that specific level.
- Technical analysts use support and resistance levels to identify price points on a chart where the probabilities favor a pause or reversal of a prevailing trend.
- Support occurs where a downtrend is expected to pause due to a concentration of demand.
- Resistance occurs where an uptrend is expected to pause temporarily, due to a concentration of supply.
- Market psychology plays a major role as traders and investors remember the past and react to changing conditions to anticipate future market movement.
- Support and resistance areas can be identified on charts using trendlines and moving averages.
Support is a price level where a downtrend can be expected to pause due to a concentration of demand or buying interest. As the price of assets or securities drops, demand for the shares increases, thus forming the support line.1 Meanwhile, resistance zones arise due to selling interest when prices have increased.
Once an area or “zone” of support or resistance has been identified, those price levels can serve as potential entry or exit points because, as a price reaches a point of support or resistance, it will do one of two things—bounce back away from the support or resistance level, or violate the price level and continue in its direction—until it hits the next support or resistance level.
The timing of some trades is based on the belief that support and resistance zones will not be broken. Whether the price is halted by the support or resistance level, or it breaks through, traders can “bet” on the direction and can quickly determine if they are correct. If the price moves in the wrong direction, the position can be closed at a small loss. If the price moves in the right direction, however, the move may be substantial
How to find Support and Resistance
2 typical ways of identifying support and resistance are:
- Horizontally aligned tops and bottoms.
- Trendlines by connecting multiple tops or bottoms.
Horizontally aligned tops and bottoms.
Market form tops and bottoms. A bottom for instance is a local price formation where prices on both sides (earlier and later) are above the lowest price in the range. When multiple tops or bottoms (or both) are horizontally aligned on the chart (or happen at the same price), we can identify an area of support or resistance by drawing a horizontal line at this level.
Trendline formations by connecting multiple tops or bottoms.
Tops and bottoms need not be aligned horizontally. They also occur in trending stocks. When the stock always forms higher bottoms (higher lows) we can draw a line that connects the different bottoms. This is called a trendline and the trendline will act as support for the next bottom formation.