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Support and Resistance can best be explained as price levels that either support prices from moving below a certain level or resist the price from moving above a certain level.
In other words these are price levels that prevent the prices from moving above or below a certain level. Though it sounds simple at first support and resistance can come in various forms and is a little difficult to master than it first appears. So let's get the basics right! Let's look at a simple example to understand Resistance.
Think you bought a share of a hypothetical company, XYZ PLC at a price of Rs. 25. You have been following the price of this share to note that the price fails to pass the Rs. 29 level although it has come closer to passing it many a time. So, this level of Rs. 29 acts as a resistance level or as a "ceiling" for the XYZ PLC stock price. In other words this price level prevents the price of XYZ share from moving above it.
The Support level is the opposite of this. If you look at a few stock charts randomly, you will see that prices of certain stocks fail to move below certain levels. Those levels are considered as a support level or a "floor" for that stock. This price level supports the price of that stock from moving below.
We'll now look at these graphically.
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As you can see form the above graph, Rs. 38 acts as a ceiling for this stock. This is the Resistance level. Prices have come closer to breaching that level but have failed a couple of times. On the other hand, Rs 30.50 acts as a floor or the Support level for the stock.
So if you hold a stock which has reached a Resistance level, which has been tested several times but not broken, it is a SELL signal because the price is having a hard time moving above that level. And if you spot a stock which is on the Support level then it is a BUY signal because the price might not fall beyond that level. Makes sense, right? However, it is important that you correctly identify these Support and Resistance levels before making trading decisions.
Round numbers such as 10, 20, 50, 100 are often cited to be important for Support and Resistance levels because at these levels most traders tend to make buy or sell decisions. The reason behind this is largely psychological.
Further, it is generally considered that once the price of a share moves above a Resistance level it automatically becomes a Support level for that stock and the price will not move below that level. On the other hand, if the price falls below a Support level that level becomes the Resistance level for that stock. This is called the "Role Reversal" of Support and Resistance. In most cases, a stock will have a Support and Resistance level and will trade within this area until it is breached and new levels are established. The following graph explains the Role Reversal more clearly, where the price level Rs. 30.50 first acts as a Resistance level and once it is breached reverses its role to a Support level.
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If you identify a Support or a Resistance level and is confident about trading at this level, it is advisable that you do not place the order at that price level itself. This is because the price does not normally reach this level but moves closer to it. So when placing the trade the price should be quoted just a few points above in the case of a Support level or just a few points below in the case of a Resistance level.
You will hear more about Support and Resistance as we move on as this concept is used in conjunction with other techniques as well.
Sri Lanka Equity Analytics
www.srilankaequity.com
Support and Resistance can best be explained as price levels that either support prices from moving below a certain level or resist the price from moving above a certain level.
In other words these are price levels that prevent the prices from moving above or below a certain level. Though it sounds simple at first support and resistance can come in various forms and is a little difficult to master than it first appears. So let's get the basics right! Let's look at a simple example to understand Resistance.
Think you bought a share of a hypothetical company, XYZ PLC at a price of Rs. 25. You have been following the price of this share to note that the price fails to pass the Rs. 29 level although it has come closer to passing it many a time. So, this level of Rs. 29 acts as a resistance level or as a "ceiling" for the XYZ PLC stock price. In other words this price level prevents the price of XYZ share from moving above it.
The Support level is the opposite of this. If you look at a few stock charts randomly, you will see that prices of certain stocks fail to move below certain levels. Those levels are considered as a support level or a "floor" for that stock. This price level supports the price of that stock from moving below.
We'll now look at these graphically.
[You must be registered and logged in to see this image.]
As you can see form the above graph, Rs. 38 acts as a ceiling for this stock. This is the Resistance level. Prices have come closer to breaching that level but have failed a couple of times. On the other hand, Rs 30.50 acts as a floor or the Support level for the stock.
So if you hold a stock which has reached a Resistance level, which has been tested several times but not broken, it is a SELL signal because the price is having a hard time moving above that level. And if you spot a stock which is on the Support level then it is a BUY signal because the price might not fall beyond that level. Makes sense, right? However, it is important that you correctly identify these Support and Resistance levels before making trading decisions.
Round numbers such as 10, 20, 50, 100 are often cited to be important for Support and Resistance levels because at these levels most traders tend to make buy or sell decisions. The reason behind this is largely psychological.
Further, it is generally considered that once the price of a share moves above a Resistance level it automatically becomes a Support level for that stock and the price will not move below that level. On the other hand, if the price falls below a Support level that level becomes the Resistance level for that stock. This is called the "Role Reversal" of Support and Resistance. In most cases, a stock will have a Support and Resistance level and will trade within this area until it is breached and new levels are established. The following graph explains the Role Reversal more clearly, where the price level Rs. 30.50 first acts as a Resistance level and once it is breached reverses its role to a Support level.
[You must be registered and logged in to see this image.]
If you identify a Support or a Resistance level and is confident about trading at this level, it is advisable that you do not place the order at that price level itself. This is because the price does not normally reach this level but moves closer to it. So when placing the trade the price should be quoted just a few points above in the case of a Support level or just a few points below in the case of a Resistance level.
You will hear more about Support and Resistance as we move on as this concept is used in conjunction with other techniques as well.
Sri Lanka Equity Analytics
www.srilankaequity.com
