Skill Sheet: What You Will Learn Here
- What are support and resistance (S/R) levels?
- The roles of the support and the resistance levels
- Charting the support and resistance levels
- How the support and the resistance levels are breached
What distinguishes us from other animals?
The human brain has the capacity for complex thinking and the ability of abundant retention. The memories retained in our mind help us recollect the past, enabling us with the power to think towards our future.
The fact that our past shapes our future could be a contributing factor to the evolution of the concept of support and resistance in technical analysis. Also, 'history tends to repeat itself' is also a basic premise on which this theory is shaped.
Let’s first understand the meaning of support and resistance and look at how history plays a role.
What is support in stock market?
- As the name suggests, the support level is a price level that lends support to a stock price from falling any further.
- It is the level from which the stock price either bounces back or remains (almost) at the same level for a while by moving sideways.
- Support level comes into the picture when the stock price is on a downslide.
What is resistance in stock market?
- The resistance level is a level where price movement faces resistance from going up.
- At the resistance level, the price either retracts or moves in a very narrow range for a considerable period of time.
- The resistance level is relevant when the stock price is moving up.
An interesting fact
So here is an interesting insight on the support and resistance levels. If a stock price breaks, its support level slides further down. That old support level becomes a new resistance level when the stock price eventually starts its upward journey.
Similarly, if the price breaches the resistance level and moves beyond it, that level usually acts as a support level in the future when the stock price starts correcting.
Before we delve deeper into the support and resistance concepts, let’s look at the noteworthy points:
- Support and resistance can work irrespective of the time-frequency of the chart – intraday, daily, weekly, or monthly.
- Since the concept of support and resistance isn’t an exact science, a stock price may not change its course exactly as per the support and the resistance levels.
- For this reason, analysts usually suggest a price band that acts as support and resistance zones.
- The more a stock price visits its support and resistance, the weaker it gets. In other words, support and resistance levels cannot remain as is perpetual. Both the support and the resistance will be broken sooner or later
Trendlines as support and resistance
The diagrams above indicate support and resistance levels, how they are breached, and new levels are created.
A trendline is a line joining highs or troughs of stock price to indicate the direction of the price movement (refer to the diagrams). While trendlines usually indicate the direction of a stock price, they also act as the support and the resistance levels. When the market is on the downslide, the trendline is drawn by joining top pivots. In the case of upward movement, the trendline is drawn by joining the bottom pivots. However, this is possible only when the market is going upwards or downwards. In other words, this indication will not be available when the market is not trending and is moving sideways.
The above price chart is that of Hindustan Unilever. The stock price has taken the support on a multi-year trendline before eventually breaking down in 2021. Later on, the same line became the resistance level. It should be noted that an intraday temporary spike in the price above or below the trendline cannot be considered a breakout.
Previous high/ low as the resistance and the support
If you recall the introduction of this chapter, we spoke about history playing a role in determining stock movement. Since previous highs/lows of a stock or index remain etched in the minds of traders for a long period, this often influences buying or selling whenever the price or index reaches that level.
Human psychology plays a role here, making traders believe that stock price will react whenever it reaches its previous levels. As a result, previous highs/lows often act as support and resistance. Previous highs and lows are often used by traders and long-term investors to make their entry and exit decisions.
In the above chart of Nifty Bank, you can clearly see the previous low/high becoming the support and resistance levels. Also, once the resistance level was broken, it became the support level for the stock when the price started correcting.
Remember, it’s not just the past stock price that acts as the support and resistance (S/R) level. There are other factors too which may influence the stock price.
IPO issue price support and resistance level
What is resistance in the case of an IPO? The issue price of a newly-listed stock in an initial public offering (IPO) may sometimes act as resistance (if it is listed below the offer price) or provide support in case of a correction. However, this rule may not hold water in the case of overpriced IPOs. In other cases, the issue price acts as good support, partly because often promoters/market makers lend support to ensure the price stays above the issue price.
Let’s study the price chart of UTI Asset Management Company Ltd, which came out with an IPO at Rs 554. Though the stock got listed below the offer price, it took some time to cross the issue price. Once reaching the issue price level, the stock hovered around that level for nearly six months. The price provided the support at the issue price during those six months.
Moving average as support and resistance
Moving average is an average of closing prices over a period of time. These moving averages often become key support and resistance levels in the technical analysis. Apart from indicating the trend, moving averages (crossovers) are used by traders for entry and exit. Because of their popularity, they often become support and resistance points.
An interesting point here is that moving averages are used by both short-term as well as long-term investors. Even intraday traders use this tool. There are various moving averages – 8-day, 21-day, 50-day, 200-day and so on – which the traders and investors use to identify support and resistance level.
In the chart of Hero Motocorp, the 200-day moving average acts as the resistance. The stock has made several attempts to break the resistance but has failed. In some cases, though the share price has crossed the moving average, it has not been able to remain above it for long and has gone below it eventually.
In the above chart, 200 DMA has acted as the support line on many occasions, though finally, the support was broken down. Once this happened, it became the resistance line when the stock price reversed its trend and started moving up. The selection of a particular moving average depends upon one’s comfort level and investment strategy. Investors with shorter investment perspectives go for shorter moving averages, while long-term investors use longer duration moving averages for identifying support and resistance levels.
Round numbers as support and resistance
You may be familiar with the concept of ‘nervous 90s’ in cricket. Often you may have seen a batter struggling nervously on the field after crossing the 90-run mark. In fact, they often end up getting out before hitting the magic figure. Something similar happens in stock markets when a stock price rises close to round figures such as 100, 200, 500, or 1,000. It also happens when the stocks are in corrective mode. Round figures often act as support and resistance for a stock price. Here support and resistance do not have any fundamental reason; it’s purely due to psychological reasons.
Similarly, 52-week lows and lows also often act as the support and resistance levels. There may be some specific reasons for which a stock price may have touched a high or low in the past. While traders/investors may not remember the reasons, they remember only the levels.
In the above chart of Maruti, round figures have acted as both resistance and support on several occasions. Note that support and resistance do not necessarily take place at the exact round figure price but somewhere near that figure.
Points to remember
- Support and resistance may not work under all circumstances, and there may be exceptions.
- When overall market sentiment is affected by external events such as the declaration of war, formation of new governments, natural disasters, etc., the stock price (or index) may find new highs or lows, surpassing all previous support and resistance levels.
- There may be some stock-specific news (positive or negative) which is disruptive in nature and may push the stock price to new levels.
- However, we may not come across such circumstances regularly.