3/7/2020 Support and Resistance Basics

TECHNICAL ANALYSIS TECHNICAL ANALYSIS BASIC EDUCATION

Support and Resistance Basics

By CASEY MURPHY | Updated Jul 6, 2019

TABLE OF CONTENTS
Defining Support, Resistance The Basics
Trend Lines Round Numbers
Moving Averages Other Indicators
Significance of Zones The Bottom Line
EXPAND +

The concepts of support and resistance are undoubtedly two of the most highly discussed
attributes of technical analysis. Part of analyzing chart patterns, these terms are used by traders
to refer to price levels on charts that tend to act as barriers, preventing the price of an asset
from getting pushed in a certain direction. At first, the explanation and idea behind identifying
these levels seem easy, but as you'll find out, support and resistance can come in various forms,
and the concept is more difficult to master than it first appears.

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Trading With Support And Resistance

KEY TAKEAWAYS
Technical analysts use support and resistance levels to identify price points on a chart
where the probabilities favor a pause, or reversal, of a prevailing trend. 
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Support occurs where a downtrend is expected to pause, due to a concentration of

demand.
Resistance occurs where an uptrend is expected to pause temporarily, due to a
concentration of supply. 
Market psychology plays a major role as traders and investors remember the past and
react to changing conditions to anticipate future market movement.

Defining Support, Resistance

Support is a price level where a downtrend can be expected to pause due to a concentration of
demand. As the price of assets or securities drops, demand for the shares increases, thus
forming the support line. [1] Meanwhile, resistance zones arise due to a sell-off when prices
increase.

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Once an area or "zone" of support or resistance has been identified, it provides valuable
potential trade entry or exit points. This is because, as a price reaches a point of support or
resistance, it will do one of two things—bounce back away from the support or resistance level,
or violate the price level and continue in its direction—until it hits the next support or resistance
level.

Most forms of trades are based on the belief that support and resistance zones will not be
broken. Whether the price is halted by the support or resistance level, or it breaks through,
traders can "bet" on the direction and can quickly determine if they are correct. If the price
moves in the wrong direction, the position can be closed at a small loss. If the price moves in
the right direction, however, the move may be substantial.

The Basics

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Most experienced traders will be able to tell many stories about how certain price levels tend to
prevent traders from pushing the price of an underlying asset in a certain direction. For
example, assume that Jim was holding a position in stock between March and November and
that he was expecting the value of the shares to increase.

Let's imagine that Jim notices that the price fails to get above $39 several times over several
months, even though it has gotten very close to moving above that level. In this case, traders
would call the price level near $39 a level of resistance. As you can see from the chart below,
resistance levels are also regarded as a ceiling because these price levels prevent the market
from moving prices upward.

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Figure 1

On the other side of the coin, we have price levels that are known as support. This terminology
refers to prices on a chart that tend to act as a floor by preventing the price of an asset from
being pushed downward. As you can see from the chart below, the ability to identify a level of
support can also coincide with a good buying opportunity, because this is generally the area
where market participants see good value and start to push prices higher again.

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Figure 2

Trend Lines
The examples above show a constant level prevents an asset's price from moving higher or
lower. This static barrier is one of the most popular forms of support/resistance, but the price of
financial assets generally trends upward or downward, so it is not uncommon to see these price
barriers change over time. This is why understanding the concepts of trending and trendlines is
important when learning about support and resistance.

When the market is trending to the upside, resistance levels are formed as the price action
slows and starts to pull back toward the trendline. This occurs as a result of profit taking or
near-term uncertainty for a particular issue or sector. The resulting price action undergoes a
"plateau" effect, or a slight drop-off in stock price, creating a short-term top.

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Many traders will pay close attention to the price of a security as it falls toward the broader
support of the trendline because historically this has been an area that has prevented the price
of the asset from moving substantially lower. For example, as you can see from the Newmont
Mining Corp (NEM) chart below, a trendline can provide support for an asset for several years. In
this case, notice how the trendline propped up the price of Newmont's shares for an extended
period of time.

Figure 3

On the other hand, when the market is trending to the downside, traders will watch for a series
of declining peaks and will attempt to connect these peaks together with a trendline. When the
price approaches the trendline, most traders will watch for the asset to encounter selling
pressure and may consider entering a short position because this is an area that has pushed the
price downward in the past.

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The support/resistance of an identified level, whether discovered with a trendline or through

any other method, is deemed to be stronger the more times that the price has historically been
unable to move beyond it. Many technical traders will use their identified support and
resistance levels to choose strategic entry/exit points because these areas often represent the
prices that are the most influential to an asset's direction. Most traders are confident at these
levels in the underlying value of the asset, so the volume generally increases more than usual,
making it much more difficult for traders to continue driving the price higher or lower.

Important: Unlike the rational economic actors portrayed by financial models, real
human traders and investors are emotional, make cognitive errors, and fall back on
heuristics or shortcuts. If people were rational, support and resistance levels
wouldn't work in practice!

Round Numbers
Another common characteristic of support/resistance is that an asset's price may have a
difficult time moving beyond a round-figure price level such as $50. Most inexperienced traders
tend to buy or sell assets when the price is at a whole number because they are more likely to
feel that a stock is fairly valued at such levels. Most target prices or stop orders set by either
retail investors or large investment banks are placed at round price levels rather than at prices
such as $50.06. Because so many orders are placed at the same level, these round numbers
tend to act as strong price barriers. If all the clients of an investment bank put in sell orders at a
suggested target of, for example, $55, it would take an extreme number of purchases to absorb
these sales and, therefore, a level of resistance would be created.

Moving Averages
Most technical traders incorporate the power of various technical indicators, such as moving
averages, to aid in predicting future short-term momentum, but these traders never fully realize
the ability these tools have for identifying levels of support and resistance. As you can see from
the chart below, a moving average is a constantly changing line that smooths out past price
data while also allowing the trader to identify support and resistance. Notice how the price of
the asset finds support at the moving average when the trend is up, and how it acts as
resistance when the trend is down.

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Figure 4

Traders can use moving averages in a variety of ways, such as to anticipate moves to the upside,
when price lines cross above a key moving average, or to exit trades, when the price drops
below a moving average. Regardless of how the moving average is used, it often creates
"automatic" support and resistance levels. Most traders will experiment with different time
periods in their moving averages so that they can find the one that works best for this specific
task.

Other Indicators
In technical analysis, many indicators have been developed to identify barriers to future price
action. These indicators seem complicated at first, and it often takes practice and experience to
use them effectively. Regardless of an indicator's complexity, however, the interpretation of the
identified barrier should be consistent to those achieved through simpler methods.

1.62
The "golden ratio" used in the Fibonacci sequence, and also
observed repeatedly in nature and social structure.
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[2]

For example, the Fibonacci retracement tool is a favorite among many short-term traders
because it clearly identifies levels of potential support/resistance. The reasoning behind how
this indicator calculates the various levels of support and resistance is beyond the scope of this
article, but notice in Figure 5 how the identified levels (dotted lines) are barriers to the short-
term direction of the price.

Figure 5

Measuring the Significance of Zones

Remember how we used the terms "floor" for support and "ceiling" for resistance? Continuing
the house analogy, the security is how a rubber ball that bounces in a room will hit the floor
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(support) and then rebound off the ceiling (resistance). A ball that continues to bounce between
the floor and the ceiling is similar to a trading instrument that is experiencing price
consolidation between support and resistance zones. Now imagine that the ball, in mid-flight,
changes to a bowling ball. This extra force, if applied on the way up, will push the ball through
the resistance level; on the way down, it will push the ball through the support level. Either way,
extra force, or enthusiasm from either the bulls or bears, is needed to break through the support
or resistance.

Often, a support level will eventually become a resistance level when the price attempts to
move back up, and conversely, a resistance level will become a support level as the price
temporarily falls back. Price charts allow traders and investors to visually identify areas of
support and resistance, and they give clues regarding the significance of these price levels. More
specifically, they look at:

Number of Touches
The more times the price tests a support or resistance area, the more significant the level
becomes. When prices keep bouncing off a support or resistance level, more buyers and sellers
notice and will base trading decisions on these levels.

Preceding Price Move

Support and resistance zones are likely to be more significant when they are preceded by steep
advances or declines. For example, a fast, steep advance or uptrend will be met with more
competition and enthusiasm and may be halted by a more significant resistance level than a
slow, steady advance. A slow advance may not attract as much attention. This is a good example
of how market psychology drives technical indicators.

Volume at Certain Price Levels

The more buying and selling that has occurred at a particular price level, the stronger the
support or resistance level is likely to be. This is because traders and investors remember these
price levels and are apt to use them again. When strong activity occurs under high volume and
the price drops, a lot of selling will likely occur when price returns to that level, since people are
far more comfortable closing out a trade at the breakeven point rather than at a loss.

Time
Support and resistance zones become more significant if the levels have been tested regularly
over an extended period of time.
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The Bottom Line

Support and resistance levels are one of the key concepts used by technical analysts and form
the basis of a wide variety of technical analysis tools. The basics of support and resistance
consist of a support level, which can be thought of as the floor under trading prices, and a
resistance level, which can be thought of as the ceiling. Prices fall and test the support level,
which will either "hold," and the price will bounce back up, or the support level will be violated,
and the price will drop through the support and likely continue lower to the next support level.

Determining future levels of support can drastically improve the returns of a short-term
investing strategy because it gives traders an accurate picture of what price levels should prop
up the price of a given security in the event of a correction. Conversely, foreseeing a level of
resistance can be advantageous because this is a price level that could potentially harm a long
position, signifying an area where investors have a high willingness to sell the security. As
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mentioned above, there are several different methods to choose when looking to identify
support/resistance, but regardless of the method, the interpretation remains the same—it
prevents the price of an underlying asset from moving in a certain direction.

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Related Terms
Support (Support Level) Definition
Support refers to a level that the price action of an asset has difficulty falling below over a specific period
of time. more

Speed Resistance Lines

Speed resistance lines are a tool in technical analysis that is used for determining potential areas of
support and resistance. more

Resistance (Resistance Level)

Resistance is the uppermost price level of an asset over a period of time. more

Tirone Levels Definition

Tirone levels are a series of three sequentially higher horizontal lines used to identify possible areas of
support and resistance for the price of an asset. more

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Zone of Support
Zone of support refers to a price zone reached when a security's price has fallen to a predicted low,
known as a support level. more

Breakdown Definition
A breakdown is a downward move in a security's price, usually through an identified level of support, that
portends further declines. more

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