Support and Resistance Levels: What Are They & How Do They Work?
Trading in stock markets is quite a complex mechanism, and you need expert knowledge of all the elements like trading price, trading volume, and reading market trends to come out on top. In this regard, support and resistance are two basic concepts in the world of trading.
It is crucial to have a sound knowledge of these concepts to read and analyse price charts accurately. Traders often use these technical concepts to point out price levels of a security at which a current trend may strengthen or weaken. Let’s consider more about these technical indicators and see how to use them in actual trading scenarios.
What Are Support and Resistance Levels?
In simple words, resistance and support levels are the points at which you will witness the maximum buying and selling of a security. The support point will have a higher number of buyers than sellers. On the other hand, a resistance price level indicates that a particular security is experiencing selling pressures, and there are more sellers than purchasers.
Resistance, in literal terms, means something that stops a price rise. At this level, market participants will witness maximum selling pressure with the many sellers operating in that particular security. However, you must remember that a resistance level will always be higher than the current trading price. Traders see the resistance level as an alarm signal for a sell-off.
Now let’s go through the concept of support level very quickly. As the name goes by, this level will arrest price decline, i.e., prevent the price of a security from falling further. At this level, you can see the highest buying pressure, i.e., buyers will be maximum. If security falls to the support level, it will bounce back and rise again. However, the support level can never exceed the current market price. It has to be lower than the prevailing trading price.
Now that you know the meaning of support and resistance level, let’s divert our attention to some other aspects of these technical trading indicators.
How Do Support and Resistance Levels Work?
As you know the basic definition of support and resistance levels, we will start discussing the working of support and resistance levels. To clear out your understanding of this concept, we will take the help of an example.
- Understanding Support Levels with Example
Suppose a group of traders buy security very close to the support level. The support price of that security is ₹100. This group of traders bought a hefty amount at ₹100. As the demand for this security rises, the price will also see a commensurate upward movement. Let’s say that the price level has moved up to ₹120.
Now, these buyers want to buy more shares at ₹100 but not at ₹120. Therefore, they agree that they will start buying more shares once it again reaches ₹100. Hence, traders are creating immense buying pressure on ₹100, which is the support level.
There is another batch of traders, but they lack conviction in their approach. They keep thinking of buying a stock at ₹100 but never did so when the price was ₹100. When it increased to cross ₹ 100, they got disappointed with their activity. Hence, they decide to buy stocks at ₹100 the next time it reaches that point. This again creates buying demand at ₹100, which was the support level.
- Understanding Resistance Levels with Example
This brings us to understanding the working of resistance indicators. We will consider the two sets of traders discussed above to explain the resistance level. All the traders own stock at ₹100. Now when the price reaches ₹120, they do not sell it and book profits and think that it will rise further. However, the stock does not see a rise, but there is a fall back to ₹100.
In the above scenario, these traders will experience regret and disappointment for not booking profits. Then, they resolved not to wait for the price to rise more than ₹120 and sell their securities as soon as the price reached that level. Therefore, there is huge selling pressure on ₹120, which is your resistance level.
Support and resistance are significant trading indicators that give traders a buying or selling signal. Resistance provides a selling signal, whereas support gives you a buying signal. However, if you are looking to use these indicators, consider pairing these indicators with other indicators, as overreliance on one can lead to inaccurate trading positions.
Frequently Asked Questions
Q1. What is the use of support and resistance levels?
Ans. Any fall at the support levels indicates that one should buy or opt for a long position in trading. On the other hand, any rise in resistance level will mean that you should sell or undertake a short position.
Q2. Is there any tool to use for support and resistance?
Ans. Yes, you can use a very popular tool, i.e., trendline, while using support and resistance levels. Trendline will help in identifying ideal support and resistance levels. It can be formed by joining more than two price points which are the highs or lows of that security.
Q3. What are important components that help in determining resistance and support points?
Ans. Some important components that go a long way in determining resistance and support are time period, trading volume, price movements and touch count.
Q4. What are support and resistance reversals?Ans. A support level can convert into a resistance level if a security’s price is rising. On the other hand, the resistance level can convert into a support level if the price declines temporarily. This mechanism is called role reversals of support and resistance levels.