In trading, support and resistance are the fundamental concepts that guide your decision-making. They are the psychological markers that help traders forecast price movements and refine their strategies. Understanding these levels can make a big difference in how you approach the markets. Let’s dive into their importance:
What is support?
Support is a level from where the price is expected to rise. When buyers outnumber sellers, prices often bounce back from this level. Think of it as a floor that prevents prices from falling further. Interestingly, when prices break below support, this level often turns into resistance.
For instance, if a stock falls below ₹500 (previous support), that ₹500 level might now act as a barrier when the stock attempts to climb back up.
What is resistance?
Resistance is the opposite—it’s a ceiling where selling pressure outweighs buying interest, causing prices to reverse. When selling occurs repeatedly near a specified level, resistance forms at that price level. If prices manage to break above resistance, this level often transforms into a new support.
For instance, if a stock rises above ₹ 1,200 (former resistance), ₹ 1,200 might now act as a floor for future price action.
Identifying support and resistance levels
Support and resistance levels can provide valuable insights for traders.
- Identifying Patterns: Usually, stocks respect the support and resistance levels through predictable patterns. Traders adopt the strategy of buying near support and selling near resistance in a range bound market as a profitable strategy.
- Key Trends: A price level approaching from below and rebounding upwards forms support while a price level approaching from above and bouncing back down forms resistance. A support gives an indication to buy the stocks, and a resistance gives an indication to sell the stock.
The above Semiconductor HOLDERS (SMH) chart shows price respecting support and resistance lines.
The above Alcoa (AA) chart shows the trend of dropping support and resistance levels over time.
Support and resistance zone: The trading base
Demand zone (Support): A range where buying pressure builds up pushing prices higher.
Supply zone (Resistance): A range where selling pressure builds up, causing prices to drop.
Trading base is the length of time prices trade in a support or resistance area. The longer prices trade within an area the greater the opportunity for prices to penetrate either the support or resistance line.
EXAMPLE: If a stock trades between ₹ 1,000 and ₹ 1,200 for weeks and breaks above ₹ 1,200, the breakout could signal a strong upward trend.
EXAMPLE:
Key levels for HDFC Bank December 2024:
Support levels: Around ₹ 1,864 to ₹ 1,868, based on recent lows observed earlier this month.
Resistance levels: The 52-week high of ₹1,880 acts as a critical resistance. Breaching this could open the path for further upward momentum.
Understanding Investor Expectations
Trader’s expectations are directly reflected in support and resistance levels. When investor’s expectations change, a breakthrough in support or resistance occurs.
When traders anticipate higher prices, resistance levels break, creating new support. You’ll notice higher highs and higher lows on the chart. In contrast, if bearish sentiment prevails, support levels give way, and resistance levels drop. This results in lower highs and lower lows.
Support and Resistance Indicators
- Look for levels where historical prices reversed multiple times in the past.
- Use tools like 50-day or 200-day Moving Averages to spot support/resistance.
- Connect highs or lows to visualise support/resistance levels.
- High trading volume near certain levels often strengthen their significance.
- Fibonacci retracement is a technical tool to identify potential support and resistance zones.
Trading smart with support and resistance
Begin with setting an entry point. One should always buy near support, anticipating a rebound. Also, set an exit point too. Try to sell near resistance, expecting a pullback. Most importantly, never forget to place stop-loss orders below support (for long trades) or above resistance (for short trades).
Conclusion
Support and resistance levels are essential for understanding market behaviour, and planning your trades. They help you identify opportunities, manage risks, and confidently navigate trends with confidence. While these levels are powerful, always combine them with additional indicators like RSI, MACD, or volume analysis to confirm your strategy. By mastering support and resistance, you can build a solid foundation for successful trading.