Support and Resistance
Support and resistance
represent key junctures where the forces of supply and demand meet. In the
financial markets, prices are driven by excessive 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.
What Is
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 does not always hold 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. Technical analysis is
not an exact science and it is sometimes difficult to set exact support levels.
In addition, price movements can be volatile and dip below support briefly.
Sometimes it does not seem logical to consider a support level broken if the
price closes 1/8 below the established support level. For this reason, some
traders and investors establish support zones.
What Is Resistance?
Resistance is the price level at which selling is thought to be
strong enough to prevent the price from rising further. The 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.
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.
Methods to
Establish Support and Resistance?
Support and resistance are like mirror images and have many
common characteristics.
Highs and Lows
Support can be established with the previous reaction lows.
Resistance can be established by using the previous reaction highs.
Conclusion
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 demand (bulls) has gained the upper hand and a support break signals that
supply (bears) has won the battle.
Thank you :)
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