What Is Support And Resistance Technical Analysis Part 1
Support and resistance Is a fundamental concept of technical analysis that all traders (day traders, retail traders, financial institutions, etc.) use as a basis to read the financial charts. Let’s understand this concept better.
Support and resistance as a technical analysis indicator are price levels on a chart that will potentially act as a barrier prohibiting the price from moving past that point in the direction of its movement. These are deemed supply and demand levels and do not necessarily show a trend.
In this article, I will primarily discuss support and resistance regarding technical analysis and the financial markets. I’ll cover the subjective concept of supply and demand and how we draw on support and resistance from them. We will also look at the human psyche and how it plays a role in determining these levels.
What is support and resistance?
One of the more frequently used ideas (concepts) that you will hear (especially if you are new to trading) is that of the term; support and resistance.
Understanding what support and resistance are, is not that difficult or complicated. In its most basic definition, support and resistance are fictitious barriers that prevent the price of an asset (stocks, forex, etc.) from moving past a specific point. Depending on where those points are and how the chart is being analyzed, then those fictitious points will either be support or resistance.
Here is an example; As you can see, the USD/CAD price is around 1.28 now; if we look back at certain points in time, roughly around mid-July, August, and September, then also in December of 2021, then again in March of 2022, and somewhat in May. We can see that price tried to climb past this price point but was halted every time it got close, and then it was rejected and pushed back down.
Note that these support and resistance levels are depicted on the chart with white arrows.
Conversely, when it broke up past that price point in June and July of 2022 and came back down, we can see that it had a reverse effect, and as the price came down to hit that point, instead of bouncing back down, it bounced back up.
Now, when the price moves up and hits this invisible barrier and moves back down, we say that the level is a resistance level. Oppositely when the price moves down and hits this invisible level, we deem that to be a support level.
Depending on the market, the analysis, and other factors, these levels are subject to occur anywhere. However, as you can see, you can easily spot them.
Take into consideration that this type of support and resistance does not show a trend but rather barrier levels that the price does not move past. When we discuss other technical analysis indicators like trend lines and patterns, we will see that manipulating these support and resistance levels in various ways will help us understand trends and enable us to read and analyze the charts more intricately.
However, that Is a lesson for another day, and the subsequent articles to this guide you will be able to find here.
The last thing we need to touch on is that, for now, we are not taking into consideration whether or not the candle bodies or wicks should be considered. Our main priority is to understand and be able to spot these levels. Moreover, in our subsequent guides, we will also be detailing the difference between major and minor support and resistance levels as well as other factors, but for now, the most crucial takeaway is to understand this;
* This type of basic technical analysis helps analysts identify points on a chart where there will potentially be a high probability of price pausing or even reversing in the opposite direction.
* A support level is when the price moves down and is halted due to an increase in buyers (Demand).
* A resistance level is when the price moves up and is halted due to an increase in sellers (supply)
* Support and resistance levels don’t necessarily show a trend, but when used in conjunction and manipulated in specific ways (trend lines and patterns), then they can.
Why do support and resistance levels occur?
In order to understand why support and resistance levels occur, we will need to consider the human psyche for a moment. The fact is that the human condition can have a big role to play in the markets.
Understanding supply and demand
In order to understand support and resistance, we will need to understand what supply and demand are. Let’s adjust our focus and think of commerce for a moment.
For example, let’s say that there is a very popular product, and as it is initially released, the price to purchase is a specific one. Now, because everyone wants to get their hands on this product, it is not uncommon for many individuals to push the price higher by buying this product and then trying to resell it at a higher value at a later date.
There is demand for this product; as such, you won’t be able to find this product at a cheaper value than its initial cost, and moreover, many stores or individuals will push the price higher, trying to make more of a profit from it. As we said, there is a demand for it.
Consider that even if you can find this product for its initial retail price, you probably won’t be able to find it for a cheaper price than that. This initial retail price can be considered to be this product’s (assets) support level.
When there is a demand for something, it will always have its support level (the lowest price you can find). As such, when the price of the product hits this level, many individuals understand this and will buy as much of the product as possible.
Also, consider that there will always be price fluctuations (meaning the price of the product will go up and down over time).
Consider that we are trying to relate a fictional situation to help you understand how the concept of support and resistance works.
Suppose we have to correlate this to the financial markets. In that case, we can understand that by reading a chart and finding support levels, we understand that this price level is one that traders (and, more likely financial institutions) find very valuable. They deem this price point to be the lowest and most acceptable point, whereby they will buy as much of it as possible and then sell it later for a marked-up value.
Conversely, if we look at our commerce example once again, but now there is an influx of production in this product because the company can see its value. As such, the market becomes flooded (supply) with this product, and due to that fact, it will not be uncommon for stores and individuals who now have a surplus of it to try and sell it for its maximum price or even a cheaper one because there is only so much a person is willing to spend on this product, and there are now too many available.
Once the market is over-saturated with the product and the maximum price is established, it won’t be easy to try and sell this product (asset) for a higher price.
This is the product’s max value and can be considered to be its resistance level. Suppose we have to correlate this to the financial markets and find levels of resistance. In that case, we can understand that traders and financial institutions understand that this price level is one that they find to be its maximum. When the price hits this level, they tend to sell the asset at a profit (providing they bought it when it was low at its support level).
This is the basis of supply and demand and how the human psyche tends to control the markets. No data or concrete evidence says an asset has to have a specific price. Traders and financial institutions decide what support and resistance levels should be based on objective and subjective factors.
Supply and demand become support and resistance
Now that we understand what supply and demand are and moreover we touched on how they become support and resistance, let’s drill this concept home.
In the example below, we are looking at GBP/USD. I have drawn two horizontal dotted white lines indicating support and resistance levels.
Consider that when the price moves past support or resistance (it breaks through), support will become resistance and vice versa. We will consider this phenomenon in the following articles, but for now, you can just take note of this.
As we can see in the example, even though the chart looks wild and out of control, within seconds, we can spot price points where price will potentially stop, and in many cases on the chart, it has.
These are subjective supply and demand zones that traders and financial institutions have deemed to be points that are subjectively valuable either in terms of buying or selling the asset.
These supply and demand zones are literal support and resistance zones (levels) that we can see and mark out on our charts.
The following articles for this complete guide will detail how to spot and draw these levels with ease.
The last thing to consider is that support and resistance levels are not finite. This means there will be instances where the price moves slightly past this level and then rebounds. This happens for many reasons.
The markets are subjective, and all traders will view the price, patterns, and technical analysis slightly differently. Then you may also have calculated decisions via financial institutions. They know and understand these points and will stop out traders to build up liquidity to drive the price in the direction they want.
What other factors contribute to support and resistance?
We stated that the human psyche of traders and institutions plays a role, and there are actually many factors that you can consider when trying to establish and understand support and resistance levels.
Round numbers affect support and resistance levels
Another factor that you can consider is round numbers. It is common for retail traders and investors to buy or sell an asset at round numbers. For some reason, many individuals regard the price at round numbers subconsciously to be more valuable.
For example, if the price of a stock is falling from a price of $15 per share. Instead of putting in buy orders at 13, 12, or 11 dollars, 95% of traders will opt to buy at round number 10. The same principle can be used for selling. Once a price hits a certain height, most traders will opt to sell at round numbers or at least wait until the price gets as close to it as possible.
Take, for instance, our example below of Amazon stock. I have marked out the support and resistance levels at round numbers 175, 160, 145, and 125.
As you can see, these are actual levels of support and resistance; in some cases, they are major levels of support or resistance.
As I said, we will be discussing support and resistance more in-depth in the subsequent articles. The key takeaways are as follows;
* Supply and demand are subjective concepts relating to an undersaturation or oversaturation of an asset.
* When those levels are decided upon due to subjective and objective factors, they are drawn as support and resistance levels on financial market charts.
* When the price moves past support or resistance, the levels reverse, making support resistance and resistance support.
Support and resistance Part 1 summary
Support and resistance are part of the most basic technical analysis tools that we as traders must understand and use to be able to analyze and read the markets. The concept is simple enough to understand.
These are subjective levels that price will potentially pause and rebound off of and are highly valued and sought out as points of interest by traders and financial institutions.
This is the basis of all trading in terms of technical analysis, and this concept has to be completely understood if you ever want to understand precisely how technical analysis works.
If you are interested in a video explanation of this concept then watch this video from one of our other traders below. Take note that this series in support and resistance is both in an article and video format. visit our YouTube channel here to check out the complete support and resistance video course.