Support and Resistance are the Most Powerful Indicators in the Stock Market Trading
Updated: Aug 30, 2021
Support and Resistance are the key price levels in which major bulls or bears present and sometimes they fight with each other to give a decisive move in one direction.
What is Support?
Support is the price level at which demand is assumed strong enough to prevent a further fall in the price.
At this level, buyers are more inclined towards buying and sellers are less inclined towards selling.
What is Resistance?
Resistance is the price level at which selling is assumed strong enough to prevent the price from rising.
At this level, sellers are more inclined towards selling and buyers are less inclined towards buying.
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Why do Support and Resistance Occur?
Prices have memory. In other words, people do remember the important levels of any instrument, which makes them important for their psychology and supply & demand in the market.
As the price rises from support levels, traders who took a long position already feeling happy and will think to add a position, in case the price comes back to support level.
The next category is traders who missed the previous trade and will be eagerly waiting to take their new position if the price shows a pulls back to the original support level.
The last category is traders who took a short position and will not be happy when the price is going up. They will be looking for a price point to exit their positions asap with less loss.
When the price gives a pulls back to the original level, their loss is less, so they will try to close their short positions. Hence, they will indirectly turn as buyers.
The combination of efforts from these 3 types of traders creates the buying force at the support level, which stops the fall in price and instead pushes it upwards. How far it will go in the north direction depends on the buying force created at the support level at that point in time.
However, it is not mandatory for the price to stop falling and trend in the upward direction whenever it reaches any support level, because it depends on many factors, including the importance of the particular support level, overall market sentiments, and level of buyers’ participation based on their perception of supply and demand.
Similar logic is also applicable to resistance, and when the price reaches any resistance levels.
Support and Resistance concepts also work well in intraday trading. Trading opportunities do exist in all the timeframes in the market. An intelligent trader has to wait and spot the right opportunities to make profits in the stock market.
Support Turning into Resistance
Another important point to note is that support can turn into resistance and vice versa.
Once the price breaks an important support level, the broken level can turn into resistance. The break of support signals that the forces of supply have overcome the forces of demand.
Therefore, if the price returns to this level, the chance of more supply is high, hence causing resistance.
The above image shows an example for support turning into resistance.
The 156 level acted as a support earlier. However, during mid-august, the price broke this level and started trading down.
Later the same 156 level acted as resistance a few times.
Resistance Turning into Support
Another concept is resistance turning into support.
As the price breaks above the resistance, it indicates changes in supply and demand.
This breakout shows that the forces of demand have taken control over the forces of supply.
If the price returns to this level, there is a chance of an increase in supply, and hence, it will act as a support.
Trend Line as Support and Resistance
Trend lines are very important to identify the trend, its confirmation, and reversal.
A trend line is a straight line that connects 2 or more price points and then extends into the future to act as a line of support or resistance.
The higher the number of peaks it connects, the stronger the trend line.
An uptrend line has a positive slope and is formed by connecting 2 or more low points. Note that at least 2 points must be connected before the line is considered a valid trend line.
Uptrend lines act as support and indicate that the demand is increasing, even as the price rises. A rising price with an increase in demand is bullish, and as long as prices remain above the trend line, the uptrend is solid and intact.
A downtrend line has a negative slope and is formed by connecting 2 or more high points.
The second high must be lower than the first for the line to have a negative slope. These trend lines act as a resistance and indicate net supply increases, even when the price decreases.
A declining price combined with increasing supply is bearish and shows strong action by the sellers. As long as prices remain below the downtrend line, the downtrend is solid and intact.
A break above the downtrend line indicates that net supply is decreasing and that a change in trend could be imminent.
How to Trade with Support and Resistance
After drawing the support and resistance trend lines, one can look for candlestick formations to take a trade.
For example, if there is a valid support line and the price shows a bullish candlestick formation (bullish engulfing, or hammer, or bullish harami), one can plan a 'Long' trade above the bullish candle, keeping a stop-loss below the bullish candle.
The above image shows an example.
The price was in an uptrend, there is a valid support trend line. Then the price displayed a 'Bullish Engulfing' pattern at the support trend line.
So, one can plan a long trade above the high of the bullish engulfing, keeping a stop-loss below the low of the same candle.
The above image shows another example.
The price was sideways to downtrend, there is a valid resistance trend line. Then the price displayed 'pinbar' pattern at the resistance trend line.
So, one can plan a short trade below the low of the pinbar, keeping a stop-loss above the high of the same candle.
This type of trading is also called 'Price Action Trading'.
Conclusion
Support and Resistance is a powerful concept in stock market trading. Many trading strategies like Price Action Trading, Breakout Trading have been developed using this concept.
Price confirmation is necessary via powerful candlestick formations to plan trades at support and resistance levels.
The price will not respect support or resistance every time. When it breaks the support, it will act as resistance in the future (and vice-versa).
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