Support & Resistance - a trader’s “best friend”
If someone were to tell you that the future prices of the securities or assets can be predicted, wouldn’t life be much easier? This is where the concept of Support and Resistance comes in. In laymen’s terms Support is the area beyond which the price does not fall & Resistance is the exact opposite, that is, the price doesn’t cross this ceiling. These price barriers are formed due to higher levels of buying & selling near the Support and Resistance. Although these act as primary technical indicators for buying and selling they are not always precise. Support and Resistance are dynamic in nature which means weak Support and Resistance can be easily broken and strong may or may not be violated. Such fluctuations in either direction are known as “breakouts”.
To get a clearer image of what Support and Resistance are and how they reverse roles lets walk through Mr. A’s trading experience. Mr. A has a share X, that he bought at Rs. 10 in March. Now he realizes that between March and June the share (in an uptrend) fluctuated between Rs 10-15 but did not break out until June. Here Rs 10 acted as a support price and Rs 15 acted as the resistance. Each time the share gets closer to the support, traders tend to see it as a suitable entry point and hence we see a pullback in the price due to a high buyer concentration. In the same manner whenever the price approaches the resistance, traders who bought the security near the support levels tend to sell it and hence the price is pushed back down due to high seller concentration. Subsequently Mr. A noticed that once the share had its breakout the resistance i.e. Rs 15 became the new support for the share & a new resistance level formed at Rs 20. The key to using Support and Resistance to your benefit is to understand and strategize how and where to place your trade entry and exit points.
The first step to strategizing would be to learn how to draw your Support and Resistance levels. The simplest method to do so is by first choosing a timeframe for your analysis. Follow this up by drawing a line joining all the significant highs forming the resistance and then joining all the significant lows forming the support. An important fact for traders to keep in mind is that Support and Resistance must be treated as areas and not just lines on the chart. Security/asset prices do not always move in sync with the trendlines. For example, Mr. A’s analysis shows the initial support was at Rs 10 but the price could possibly rebound even from a Rs 10.50 range if there is enough buyer concentration. This would mean that Mr. A misses his trade because he was waiting for the stock to reach the exact price.
This brings us to the most commonly practiced Support and Resistance trading strategy, i.e. Range Trading. Herein traders enter long when prices bounce back from the support and go short when prices pull back from the resistance. This is beneficial only in range bound securities. An important aspect to keep in mind is that in a downtrend going long at the support would be risky as the support may break and same is the risk with going short on a price near the resistance in an uptrend. To not fall prey to such mistakes, a trader should look out for major support and resistance levels and volumes. If any breakout is supported with heavy volumes, then it confirms the trend reversal.
When you understand how to use Support and Resistance strategies, you can move to more advanced methods such as moving averages as support and resistance, or using Fibonacci numbers. Moreover, most technical tools have some form of Support and Resistance beaded into it and hence it’s important for every trader to understand the functioning of the same.
- Support and Resistance are price areas.
- Support and Resistance are dynamic in nature and consist of weak and strong Support and Resistance levels.
- Weak Support and Resistance levels break easily, Major Support and Resistance levels either lead to trend reversals or breakouts in case of high buyer/seller concentration.
- Support and Resistance levels help you to identify entry and exit points.
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