Introduction Support and Resistance
Support and Resistance
We can imagine the support and resistance as a floor and a glass ceiling limiting the excursion of the market movement. Understanding these important concepts will help us to develop a disciplined trading strategy.
The dynamism and volatility of the market prices are the result of continuous variation of the game of balance between supply and demand. When supply exceeds demand, prices tend to fall, conversely when supply is insufficient to meet demand, prices tend to rise.
Technical analysts identify trends in training on studying the markets at price levels which balances change. Although these levels are created in a natural way, without following any program, represent the collective opinion of the parties operating on the market.
Support is the price level at which a downward stops their fall and potentially ‘bounces’ back up (the lower black line in the graph).
This is because the potential buyers, given the fall in the price, decide it’s a good time to enter the market. The excess supply is then absorbed, as long as supply and demand do not rebalance and descent stops. Since the number of buyers increases, the balance is tipped back to the question and the prices begin to rise again.
Technical analysts can identify the probable support levels, but without any guarantee given that the markets are never completely predictable. It is worth mentioning that if the price exceeds the expected support level, will continue to fall until they find another medium.
The resistance is the opposite of the support. It is the level at which a rising price located to growth resistance and potentially drops (the black line in the upper graph).
This is because potential sellers, given the growth of the price, decide it’s a good time to sell. This generates an increase in supply on the market, which eventually reaches the demand by creating a new balance. A growing number of vendors, however, tries to exploit the bullish market, creating a sales force to push prices down again.
Some technical analysts believe that a price that violates the expected resistance level may continue to rise until reaching the next resistance.
“Bear” Markets and “Bull” Markets
These terms are used to describe the thought of two different groups of operators.
They are the sellers, who suppose that prices are destined to fall. A “Bear” market is a market in which prices are declining.
They are the buyers, who suppose that prices are bound to rise. A “bull” market is a market in which prices of a single item or title is higher.
Like a sideways trend becomes bullish
In a lateral trading range, the market is relatively stable with a limited degree of volatility, defined by the support and resistance levels.
However, market conditions may change for a number of reasons. If market conditions improve, for example, the balance between supply and demand is altered.
Here is the example of a sequence of events:
Let’s assume that a company announces positive earnings estimates.
Sellers (the offer) will be less likely to sell and remain attached to their assets in the hope that the company value purchases.
Buyers will be rather eager to enter the market.
When the price approaches again to the previous resistance level, the number of “bears” will increase while that of “bulls” will decrease.
This allows prices to break through the previous resistance level, creating what is commonly called ‘break-out’, ie the birth of a new trend.
However, not all the bulls and the bears change their minds. Most of the news concerning investment is subject to interpretation, and some investors might not have got the message. If These investors have not reacted to the above it will consolidate the upward movement of the price in a new trend. That’s how:
Some short sellers, who sold the asset to open a position, the stop loss will be placed on the previous resistance level, in order to close the position and limit losses in the event of a rise in prices. When these orders are triggered by the price, the short sale closes with the purchase. This creates more demand and contributes to the bullish phase of the market.
Other buyers who had previously decided not to participate may notice that the side stage has been broken and decide to take a stand. This leads to a further increase in demand, raising still more the prices.
Conditions for a new level of support
Now the market has broken through the previous resistance level, it may become the new support level.
Operators have seen the price to make a huge leap forward after the break of resistance and could decide to buy if the price returns to this level. The reasons could be due to emotional responses:
The short sellers who had opened a position just below the resistance level, providing for a lowering of the price, they will want to close their positions by buying if the price drops further at this level. This allows them to limit the loss rather than risk the price will rise again.
Traders who have previously taken their profits to the resistance level can identify the emergence of a new trend and decide to re-enter the market. They will want to do it as close as possible to their exit price.
Both of these examples lead to an increase in the buying pressure on the market and push up prices. Once the new level of support, there will be a new level at which buyers will want to take their profits and sell.
This creates a new level of resistance, gradually leading to an increase in the support and resistance levels.