What is the significance of support and resistance zones?

[Benjamin Schmitz]

[Sheila Olson]

Support and resistance are two of the most widely discussed components of technical analysis because they provide useful information about entry and exit points. Although support and resistance is definitely data-driven, there’s also an element of human emotion and psychology involved. Let’s start with a basic definition of support and resistance. Support is the level where a downtrend should pause due to demand, i.e. enough people will buy the stock at what is perceived as an attractive price to end the decline. Resistance, on the other hand, is the level at which an uptrend pauses due to sell-off, i.e. enough people will take their profit and close the position. If support is the floor, resistance is the ceiling. There’s a high probability of a reversal as a stock hits support or resistance, because traders take action at these levels, either to open a new position or exit an existing one. Although you usually see support and resistance drawn as a line, that simplifies things a bit too much. If it were actually possible to pinpoint the exact price of support and resistance, every trader would have an exit or entry order at that particular price. That’s why support and resistance zones are more accurate. There is a range of prices between which a stock price will brush up against, breach, and fall back from numerous times before a true reversal takes place. Identifying support and resistance zones is where human emotion comes into play, specifically fear and greed. At any particular price point, there are three types of traders:

• Those who are long and want the price to rise
• Those who are short and want the price to fall
• Those waiting for more information to decide how to trade

  Traders with a long position who see a stock begin move away from a support zone may add to their positions in the hope of making even more money (greed). Traders who shorted the stock see the same movement and buy to cover in the hope of limiting their losses (fear). Traders who haven’t taken a position may decide to jump in as the price nears the bottom of the support zone. Each of those actions further reinforces the level of support. The same thing happens in reverse as a stock trades in the resistance zone. The long trader sells to take a sure profit (fear), the short trader shorts more stock expecting a reversal (greed), and the uncommitted trader may take a short position. A final element of support and resistance zones relates to human psychology, which manifests in two ways. One is when a stock breaks through a resistance level and is essentially in uncharted territory. Without a resistance level to slow it down, the bulls continue to drive the price up with demand until sanity takes hold and a new level of resistance is established. The other psychological element is the human affinity for round numbers. Few traders, either of the retail or institutional kind, place buy or stop orders for $100.27, for example. The nice, round $100 is more appealing. Round numbers such as $50 or $100 can act as very strong price barriers when the price is fairly valued near those numbers. Ultimately, support and resistance zones are just one tool in the technical trader’s arsenal, but combined with trendlines and other indicators, they can give a significant boost to your short-term trading strategy.

[Chrispus]

Hi Benjamin,

Thanks for coming here.

Support zones mark the level at which stock prices stop sinking. They’re characterized by buyer demand surpassing that of sellers. Resistance zones, on the other hand, are levels at which asset prices stop rising. Here, the sellers exceed the buyers.
Oftentimes, a trader buys shares after prices reach the support zone hoping the stock will rebound. Likewise, they book profits by selling shares when the stock nears a resistance level. Long traders place stop orders just beneath the support. Similarly, short sellers set their stops slightly over the resistance. Powerful price movements trigger these stops resulting in automatic selling and buying.
Not to say resistance zones are permanent. In case an asset’s value passes the support level, it continues to drop until a new support level is formed. This is also the case for resistance. Unable to predict the new floor or ceiling, short sellers are likely to avoid the trade at first. The strength of these resistance zones depends on the number of times the stock bounces off them.

[Emilio Estavez]

Hello Benjamin,

The support and resistance zones the two market components traders pay attention to identify price levels on charts. Those levels play the role of a barrier that prevents the price from moving into a specific direction. Support and resistance are the most widely debated things when performing a technical analysis of the market.  

The resistance level refers to the zone that stops the price advancing further and forces it to change the direction. 

Resistance serves as an indicator for a surplus of bears. On the other hand, support refers to the zone where that stops a downtrend because of an increasing buying interest.

The two areas can take different forms with regard to price changes over time. 

The support zone forms when the demand for the stock increases during a downtrend. Conversely, the resistance zone takes shape when there’s a surplus of bears during an uptrend.

Once support and resistance have been determined, the levels serve as potential entry/exit points in the market. The reason for this is because once the price reaches one of the levels, it will either change direction or keep advancing further until a new support/resistance zone is formed. 

Investors trade the market by anticipating the price performance with regard to support and resistance. In other words, traders try and predict whether the price will change direction upon touching support/resistance or violate those zones and continue moving in the same direction.  They make their moves based on that prediction. Investors who made a correct prediction will make a profit while those who were wrong will suffer losses. 

Support and resistance are typically easy to spot on the chart as the bottom level refers to support and the top level represents resistance.
 

[Daniella]

Hi Benjamin,

Support and resistance zones are market levels where prices are likely to reverse. True to its name, a supports zone supports the price and prevents it from dipping further while a resistance zone resists price increments. Another distinction is where they form on a chart.
Appearing beneath the price, support levels indicate a possible upside swing. Conversely, resistance levels appear over the market price and hint at a downside reversal. In most cases, investors with brief holding periods have smaller stops.
The idea is getting as close as possible to the reversal to optimize the tiniest stop available while catching the upside. This is unlike long investors who prefer wider stop losses, so slight price swings do not eject them.
Sometimes, the market defies the support and resistance to form new reversal points. This calls for reliable risk management strategies. Such scenarios are common during directional uncertainty and depend on the strength of the price movement.
It’s not uncommon to lose your capital after following a false breakout. That’s why experienced investors wait for pullbacks before jumping on a trade.
 

[Rishabh Tyagi]

@Sheila Olson has give a very insightful answer. 

I would add, that they are the most considerable price action tools when analyzing the markets.

 

A price moves up when there are more buyers than sellers who are ready to buy at a higher price from the LTP (last traded price), and vice versa for price declines.

So the price movement is the result of actions between sellers and buyers.

 

In a stock, there are zones/price levels where either buyers or sellers are strong.

A support zone is where buyers can create more demand for the stock than the supply provided by the sellers.

A resistance zone is when sellers have strength. They can create more supply than the buyers can handle.

 

- They are not respected every time. That's when we have a breakout.

- A change in the perceived company's intrinsic value or some significant news can affect support and resistance zones.

- The higher the time-frame, the more significant the zone.

- The higher the number of times the price tested the level and respects it, the more trustworthy the levels get.

 

This is MRVL moving in S & R range