Explanation of Trading Tools – Support and Resistance Zones: The trading market works on the principle of supply and demand, and the prices fluctuate accordingly. Just like real life, if an asset is in demand, its prices would increase. Similarly, excess supply and less demand will decrease its cost.
Based on this supply-demand concept, there is an excellent tool for technical analysis of stocks, i.e. support and resistance levels. Professional analyzers use these tools for determining the entry and exit points as well as predict the future price level. It works on the probability of an asset’s previous price points, and for a new trader, it is a must-learn tool.
In this article, we would try to understand the meanings of support and resistance levels in detail!
A support level is a share price range at which the buyers want to buy the asset and sellers stop or reject selling their asset. As a result, it prevents the asset from further falling. A support level, or the floor of the price chart, is a point where an asset’s depression comes to a halt because of the market interest.
The reason is as an asset’s price decreases; the demand increases and more buyers get interested. Similarly, sellers reject the declining price. As a result, either the trend will reverse or stop.
However, it is also common for assets to break the support level and decline further. The support level is just a prediction and doesn’t guarantee anything. It indicates that the selling pressure was so high that the traders were ready to sell the asset at the low support level too.
And, the traders should look for another support level because the old one is broken and would be treated as a high point now, i.e. resistance level. The cause of the support level break can be bad news, conflict, or recession.
Generally, a support level is not a fixed price. It is a zone of the price range.
Similarly, Resistance level (or roof of the price chart) is a price level above which the market rejects from rising. In other words, it’s a point at which the buyer refuses to purchase and the seller, because of the high price; try to square off their holdings.
Also, it is common for resistance levels to break the price ceilings. It denotes that the seller is still maintaining trust upon the asset and hoping for further rise. Buyers are also optimistic about the instrument and keep purchasing at the high price too.
The old resistance level then becomes the support level and the roles switch. You can understand this thing with the help of the figure below.
The general perception is – at the resistance level traders should sell off their positions as the market interest does not allow anything above that.
The reason for resistance zone breakage could be some positive news, investment into the asset, or bullish market.
The Bottom Line – Support and Resistance Zones
User emotions and psychology plays a significant role here as the price level wholly depends upon the buyers and sellers reaction to inevitable price change. A good trader uses this tool frequently to decide on his future course of action. However, skill, experience, and knowledge of the trader play a significant role in the perception of the result (from the support and resistance analysis).
Remember, these tools are not scientific but based upon the past performance and previous market interest. Thus, assuming that the support or resistance level will break and holding the stock could get more loss. Please scrap off them inside these levels.
This article covered the basics of support and resistance tools. But! How to determine the support and resistance points? These can be identified by using simple tools and techniques such as Fibonacci retracement and trendlines. Check all the methods here!