Support and Resistance
Support and Resistance – Two Primary Considerations in Technical Analysis
If you are a fan of using technical analysis to evaluate stocks, then the support level and the resistance level are terms you will need to understand. Basic economics tells us that the price of most goods and services are based on the interaction of supply and demand in the marketplace. Within the stock market, prices are driven down by excessive supply and up by increased demand. All things considered, when you think about higher demand, think bullish behavior and increased prices, when you think about increased supply, think bearish behavior and lower prices.
Let’s take a closer look at what the terms support and resistance mean and how you might use them.
The price level where demand is high enough to prevent the price from decreasing is known as the support level. As the share price goes down and approaches the support level, buyers are more inclined to buy because of the lower price. When the demand level overcomes the supply level, the decline will stop. Here is a graphic representation of the support level:
As you might imagine, the support level doesn’t always hold, if it did we would all be millionaires. When the price goes below the support level, known as a support break, it means that the bears have won the battle over the bulls. A new lower support level is established because the sellers have reduced their expectations.
Considering the volatility of the stock market and that stock prices may trade near support levels, it is not uncommon for the stock price go below the support level briefly and then go back above it. For this reason, rather than establishing a support level for a given price, some investors prefer to user support zones.
The price level where selling is stronger than demand is known as the resistance level. As the share price increases and approaches the resistance level, more and more sellers will be willing to sell their shares to cash in and take profits. When the supply level overcomes the demand level, share price increase will stop. Here is a graphic representation of the resistance level:
As we saw with support level breaks, breaks also occur for the resistance level. In this case it means that the bulls have won over the bears. A higher price results from higher expectations which means that there are more buyers, less people willing to sell, or a combination of both. Some traders prefer to use resistance zones rather than resistance levels because it is not uncommon for stock prices to go above the resistance level briefly before going back down below it.
Another consideration when buying stocks is that a support level can turn into a resistance level and vice versa. For example, let’s consider the case when resistance break occurs because demand overcomes the forces of supply. With the previous resistance level now passed, if the stock price goes back down towards the previous resistance level, an increase in demand is likely to occur, thus the previous resistance level is now a support level.
Analyzing stock support and resistance levels may enhance your understanding of the potential signs of price increases or decreases but it is not an exact science by any means. When the stock price approaches a support level, watch out for the increased buying behavior. In the opposite direction, when the stock price approaches a resistance level you should be looking for signs of increased selling behavior.
When analyzing support and resistance levels, you should be aware of changes in buying and selling volumes near these levels. Recent levels are more important than historic levels and if it coincides with a new 52week low or high it is even more significant.