Suport & Resistance
Support and Resistance Trading Strategy
Strong Buying Zone
Support
Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.
Support and resistance represent key junctures where the forces of supply and demand meet. In the financial markets, prices are driven by excesses of supply (down) and demand (up). Supply is synonymous with bearish, bears and selling. Demand is synonymous with bullish, bulls and buying. These terms are used interchangeably throughout this and other articles. As demand increases, prices advance and as supply increases, prices decline. When supply and demand are equal, prices move sideways as bulls and bears slug it out for control.
Support does not always hold, however, and a break below support signals that the bears have won out over the bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive to buy. Support breaks and new lows signal that sellers have reduced their expectations and are willing sell at even lower prices. In addition, buyers could not be coerced into buying until prices declined below support or below the previous low. Once support is broken, another support level will have to be established at a lower level.
Where Is Support Established?
Support levels are usually below the current price, but it is not uncommon for a security to trade at or near support. As technical analysis is not an exact science, setting precise support levels can often be difficult. In addition, price movements can be volatile and briefly dip below support. For example, it does not seem logical to consider a support level broken if the price closes an eighth below the established support level. For this reason, some traders and investors establish support zones.
Strong Selling Zone
Resistance
Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. Logic dictates that, as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance.
Resistance does not always hold; a break above resistance signals that the bulls have won out over the bears. A break above resistance shows a new willingness to buy and/or a lack of incentive to sell. Resistance breaks and new highs indicate buyers have increased their expectations and are willing to buy at even higher prices. In addition, sellers could not be coerced into selling until prices rose above resistance or above the previous high. Once resistance is broken, another resistance level will have to be established at a higher level.
Where Is Resistance Established?
Resistance levels are usually above the current price, but it is not uncommon for a security to trade at or near resistance. In addition, price movements can be volatile and rise above resistance briefly. Sometimes it does not seem logical to consider a resistance level broken if the price closes 1/8 above the established resistance level. For this reason, some traders and investors establish resistance zones.
- Identification of key support and resistance levels is an essential ingredient to successful technical analysis.
- Even though it is sometimes difficult to establish exact support and resistance levels, being aware of their existence and location can greatly enhance analysis and forecasting abilities.
- If a security is approaching an important support level, it can serve as an alert to be extra vigilant in looking for signs of increased buying pressure and a potential reversal.
- If a security is approaching a resistance level, it can act as an alert to look for signs of increased selling pressure and potential reversal. If a support or resistance level is broken, it signals that the relationship between supply and demand has changed.
- A resistance breakout signals that the bulls (demand) have gained the upper hand and a support break signals that the bears (supply) have won the battle.