If you’re new to technical analysis, the key to predicting future price movements is to analyse chart patterns and price trends, which largely assist you in defining entries and exits from what looks like a choppy graph. Likewise, if you’re trying to analyse charts for the first time, you may perceive markets to be random and inconsistent, but experienced chartists organize this random price behaviour into systematic patterns to define entries and exits solely based on supports and resistances, which can either be short-term breakouts or long-term trend changers. In addition to supports and resistances, traders may also employ volumes and technical studies like oscillators or moving averages as secondary indicators to predict price behaviour.
So, what are supports and resistances and why are they important?
Generally, the price of an underlying financial asset rises when demand exceeds supply and drops when supply overpowers demand.
Support is the price level at which the decline in the price of an underlying security is expected to pause as demand overcomes supply. Supports are typically plotted below the current market price although it is possible that near-term supports are at or close to the current market price. Traders generally expect prices to consolidate around supports and even rebound if the demand is robust enough. However, if prices breach and close below supports, it is likely to continue falling until it finds the next support.
On the contrary, resistance is the level at which the price rise in the underlying security is expected to be curtailed as supply overwhelms demand. Resistances are typically plotted above the current market price although near-term resistances could be found at or close to the current market price. They are levels at which prices find resistance from a large number of sellers as they attempt to surge ahead. However, once resistances are broken by a certain margin, the price of the underlying security will continue to rise until they meet the next resistance level.
Supports and Resistances are primary components of technical analysis and recognizing them appropriately will help establish your entry points and the corresponding price targets. Generally, traders buy the underlying security when the price is at or close to the supports and exit when prices approach resistances. In addition, stops are placed below support lines to minimise losses in case prices continue sliding. Likewise, traders short the underlying as prices approach resistances and cover positions as prices fall close to the supports. Although there are no hard and fast rules governing trading approach as there are a wide category of traders following their customized trading strategies, identifying supports and resistances is still a key parameter used by technical analysts to forecast price levels.
How to identify supports and resistances?
Supports and Resistances can be identified and plotted in several ways depending on the kind of trader you are. While day and short-term traders look for near-term trends to identify supports and resistances, positional traders and investors are more concerned about the medium to long-term direction of prices and design their supports and resistances accordingly. We have put together a few common ways in which supports and resistances can be defined. While some of them may be easy to figure out, the others may require some amount of training and practice to be able to clearly visualize them.
1. Previous lows/highs-
The simplest way to identify supports and resistances is to consider the previous lows or highs from where prices rebounded or reversed. These price levels would then come into play the next time the underlying tries to breach the levels. If supports are disrupted, the same price levels will act as resistances in the future. Likewise, if prices settle above resistances for a certain period, the resistance lines can be used as supports in the future.
2. Breakout of trading ranges-
Trading ranges are another example where supports and resistances can be easily recognized. These ranges typically point to prices moving in a relatively tight band for an extended period with neither the upside nor downside taken out convincingly. The lower end of the trading range is generally branded as supports and the upper end resistances. Breakout from a trading range generally signifies a sharp upside or downside move, depending on the direction of the breakout.
3. Trend Reversals-
These refer to changes in the ongoing trend and can be categorized as a reversal in the uptrend or downtrend depending on the direction of the breakout. If the breakout is at the resistance, it is regarded as a bearish trend reversal while if the breakout takes place at the support, it’s considered a bullish trend reversal. Generally, trend reversals occur after a prolonged uptrend or downtrend and the breakouts lead to a sharp price move in the direction of the breakout.
4. Breakout of chart patterns-
Chart patterns occur within a series of price movements and are characterised as either continuation or reversal patterns. Breakout of these patterns generally arises when the support or resistance surrounding the chart pattern is taken out. Chart patterns can be found across timeframes, are an integral part of technical analysis and have an established breakout and target, again buoyed by support and resistance levels. Some of the popular chart patterns include double tops/ double bottoms, head and shoulders, flags, pennants, symmetrical triangles and so on.
Supports and resistances are undoubtedly the primary concepts of technical analysis. The Protrader platform offered by Compositedge to retail customers in Indian equities has a wide range of drawing and analytical tools that can assist in strategizing your trading activities seamlessly. In addition, we provide a large amount of historical data that are plugged into the readily available charts with the option to customise your charting panel and execute one-click orders directly from the chart window.