How To Identify Support Resistance Levels?
Discovering and analyzing stock price patterns are two critical functions of trading. By analyzing trends, investors and traders may evaluate if underlying market circumstances favor their positions or not, and for how long. This allows them to identify entrance and departure places; support and resistance are two key notions in this respect.
Analysts calculate support and resistance levels by analyzing price movement patterns, which function as barriers to stock price fluctuations. These levels, however, are just temporary and will alter when stock prices breach these barriers.
What Is The Difference Between Support And Resistance?
A support line is a level below which the price of a stock or asset cannot fall. Often, the price will either go towards the support line and flatten when it reaches it, or it will bounce back up. On the other side of the coin is the resistance line, which is the price level over which a stock cannot rise. As prices approach this barrier, they either stagnate or fall.
Experts define these lines based on tendencies in which a certain asset has frequently failed to breach a price threshold throughout time. While no exact support and resistance formula exists, traders use indicators such as moving averages and techniques such as the Fibonacci Retracement to calculate the levels.
Consider a stock X that has soared to a price point of ₹75 five times in six months, only to run out of gas each time. Hence, ₹75 might be identified as the stock’s current resistance line or ceiling price. In contrast, if stock X falls six times over that period before rising again after hitting ₹40, that is the support line. Understanding levels of support and resistance is crucial in defining entry and departure points for certain assets.
How Do Resistance And Support Work?
It’s important to understand right away that support and resistance levels are artificial levels created from price patterns, which are naturally tied to investor sentiments. Support and resistance lines, on the other hand, impact investor sentiment, urging them to sell or purchase, as the case may be.
Resistance Level
Traders use the resistance line as an exit point. This is because they assume that an asset’s price will fall after hitting or just before reaching the resistance line after an upward trend. As a result, the resistance level encourages traders to sell to avoid losses. Prices fall when traders sell assets in big quantities. The resistance line holds here as well.
Nevertheless, support and resistance lines do not remain static for lengthy periods but eventually, develop an upward or downward slope. As a result, most experienced traders use trendlines to calculate these price levels. Traders may better predict future price movements over time by defining the larger region of support or resistance based on trendlines. For example, a sequence of historically northward advancing lows contributes to the formation of an upward slope indicating a zone below which the price struggles to move.
Support Level
As the price of a stock approaches or reaches a certain level, traders acquire new units. This approach is driven by the belief that the support level will not be breached and that prices would finally rise.
Surprisingly, when a large number of traders acquire stocks at or around the support level, the prices quickly begin to rise owing to an increase in demand. As a result, the support level persists throughout time by influencing and being impacted by investor views, until an extraordinary event sends the price below that line.
Are The Levels Of Support And Resistance Reliable?
To establish the dependability of support and resistance lines, traders analyse four critical factors. These are as follows:
Touch Count
The number of times a price level has reached a support or resistance line only to bounce is another indicator of its dependability. A support line, for example, that consistently stops the price from dropping below it is more reliable, and hence more traders will base their purchasing choices on it. A level, on the other hand, that does not regularly hold to price movements is less relevant to traders.
Trading Volume
Taking into consideration the volume of trade, analysts often identify major price points and, as a result, support and resistance levels. A pricing point that sees significant selling or purchasing might be considered dependable.
For example, if patterns suggest that a given price action has prompted investors to sell a specific class of assets or stock in large quantities, they would most likely enter a short position when it hits that level again. That refers to the overall mindset of investors, who prefer to sell at the breakeven point rather than before it because they anticipate a continued upward trend.
Price Changes
In general, a support or resistance level is more noteworthy if it follows a sharp increase or decrease in price. This is because such a price change piques the interest of investors more than a slow-moving upward or negative trend. As a result, it is more likely to face stiff opposition or stronger support.
Period
In addition to the prior indicator, a support or resistance level becomes more dependable the longer it can withstand price movements. The number of times prices have hit that level is also important in this understanding.
Wrapping Up
Traders also consider occasions – and events before them – when price movement has breached a support or resistance line to better anticipate future occurrences. A former support line may often become a resistance line, indicating a major drop in prices. If prices rise significantly, a resistance line might also become a support line.
