Support and resistance are two foundational concepts in technical analysis. Understanding what these terms mean and their practical application is essential to correctly reading price charts.
Prices move because of supply and demand. When demand is greater than supply, prices rise. When supply is greater than demand, prices fall. Sometimes, prices will move sideways as both supply and demand are in equilibrium.
Like many concepts in technical analysis, the explanation and rationale behind technical concepts are relatively easy, but mastery in their application often takes years of practice.
Key Takeaways
- Technical analysts use support and resistance levels to identify price points on a chart where the probabilities favor a pause or reversal of a prevailing trend.
- Support occurs where a downtrend is expected to pause due to a concentration of demand.
- Resistance occurs where an uptrend is expected to pause temporarily, due to a concentration of supply.
- Market psychology plays a major role as traders and investors remember the past and react to changing conditions to anticipate future market movement.
- Support and resistance areas can be identified on charts using trendlines and moving averages.
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What Is Support?
In a downtrend, prices fall because there is an excess of supply over demand. The lower prices go, the more attractive prices become to those waiting on the sidelines to buy the shares. At some level, demand that would have been slowly increasing will rise to the level where it matches supply. At this point, prices will stop falling. This is support.
Support can be a price level on the chart or a price zone. In any event, support is an area on a price chart that shows buyers’ willingness to buy. It is at this level that demand will usually overwhelm supply, causing the price decline to halt and reverse.
What Is Resistance?
Resistance is the opposite of support. Prices move up because there is more demand than supply. As the prices move higher, there will come a point when selling will overwhelm the desire to buy. This happens for a variety of reasons. It could be that traders have determined that prices are too high or have met their target. It could be the reluctance of buyers to initiate new positions at such rich valuations. It could be for any other number of reasons. But a technician will clearly see on a price chart a level at which supply begins to overwhelm demand. This is resistance. Like support, it can be a level or a zone.
Once an area or “zone” of support or resistance has been identified, those price levels can serve as potential entry or exit points because, as the price reaches a point of previous support or resistance, it will do one of two things: bounce back away from the support or resistance level, or violate the price level and continue in its prior direction—until it hits the next support or resistance level.
The timing of some trades is based on the belief that support and resistance zones will not be broken. Whether the price is halted by or breaks through the support or resistance level, traders can “bet” on the direction of price and can quickly determine if they are correct. If the price moves in the wrong direction (breaks through prior support or resistance levels), the position can be closed at a small loss. If the price moves in the right direction (respects prior support or resistance levels), however, the move may be substantial.
The Basics
Support and resistance can be found in all charting time periods; daily, weekly, and monthly. Traders also find support and resistance in smaller time frames like one-minute and five-minute charts. But the longer the time period, the more significant the support or resistance. To identify support or resistance, you have to look back at the chart to find a significant pause in a price decline or rise. Then look forward to see whether a price halts and/or reverses as it approaches that level. As has been noted above, many experienced traders will pay attention to past support or resistance levels and place trades in anticipation of a future similar reaction at these levels.
Technical analysis is not an exact science, and sometimes the price will dip below support levels or reverse before it gets to the prior support level. The same is true for resistance: Price may reverse before it gets to the prior resistance level or break above it. In each case, flexibility is required in interpreting these chart patterns. This is why support and resistance levels are sometimes referred to as zones.
There is nothing magical about these price levels. It is simply that many market participants are acting off the same information and placing trades at similar levels.
Most experienced traders can share stories about how the price of an asset tends to halt when it gets to a certain level. For example, assume that Jim was holding a position in stock from March to November and that he was expecting the value of the shares to increase.
Let’s imagine that Jim notices that the price fails to get above $39 several times over several months, even though it has gotten very close to moving above that level. In this case, traders would call the price level near $39 a level of resistance. As you can see from the chart below, resistance levels are also regarded as a ceiling because these price levels represent areas where a rally runs out of gas.
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Support levels are on the flip side of the coin. Support refers to the price level on a chart where equilibrium is reached. This means that demand has increased to match supply. This causes the decline in the price of the asset to halt; therefore, the price has reached a floor. As you can see from the chart below, the horizontal line below the price represents the price floor. You can see by the blue arrows underneath the vertical line that the price has touched this level four times in the past. This is the level where demand comes in, preventing further declines. This is support.
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Trendlines
The examples above show that a constant level prevents an asset’s price from moving higher or lower. This static barrier is one of the most popular forms of support/resistance, but the price of financial assets generally trends upward or downward, so it is not uncommon to see these price barriers change over time. This is whythe concepts of trending and trendlines are important when learning about support and resistance.
When the market is trending to the upside, resistance levels are formed as the price action slows and starts to move back toward the trendline. When the price is moving against the prevailing trend, it is called a reaction. Reactions can occur for a large variety of reasons, including profit taking or near-term uncertainty for a particular issue or sector. The resulting price action undergoes a “plateau” effect, or a slight drop-off in stock price, creating a short-term top.
Many traders will pay close attention to the price of a security as it falls toward the broader support of the trendline because, historically, this has been an area that has prevented the price of the asset from moving substantially lower. For example, as you can see from the Newmont Corp. (NEM) chart below, a trendline can provide support for an asset for several years. In this case, notice how the trendline propped up the price of Newmont’s shares for an extended period of time.
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On the other hand, when the market is trending to the downside, traders will watch for a series of declining peaks and will attempt to connect these peaks together with a trendline. When the price approaches the trendline, most traders will watch for the asset to encounter selling pressure and may consider entering a short position because this is an area that has pushed the price downward in the past. To be a valid trendline, the price needs to touch the trendlines at least three times. Sometimes with stronger trendlines, the price will touch the trendline several times over longer time periods. Also, in an uptrend, the trendline is drawn below the price, while in a downtrend, the trendline is drawn above price.
The support/resistance of an identified level, whether discovered with a trendline or through any other method, is deemed to be stronger the more times that the price has historically been unable to move beyond it. Many technical traders will use their identified support and resistance levels to choose strategic entry/exit points because these areas often represent the prices that are the most influential to an asset’s direction. Most traders are confident at these levels in the underlying value of the asset, so the volume generally increases more than usual, making it much more difficult for traders to continue driving the price higher or lower.
Unlike the rational economic actors portrayed by financial models, real human traders and investors are emotional, make cognitive errors, and fall back on heuristics or shortcuts. If people were rational, then support and resistance levels wouldn’t work in practice!
Round Numbers
Another common characteristic of support/resistance is that an asset’s price may have a difficult time moving beyond a round number, such as $50 or $100 per share. Many people think in terms of a round number, and this carries over into the stock market. Because people have easier time visualizing in round numbers, many inexperienced traders tend to buy or sell assets when the price is at a round number.
Also, many target pricesorstop orders set by either retail investors or large investment banks are placed at round price levels rather than at prices such as $50.06. Because so many orders are placed at the same level, these round numbers tend to act as strong price barriers. For example, if all the clients of an investment bank put in sell orders at a suggested target of $55, it would take an extreme number of purchases to absorb these sales and, therefore, a level of resistance would have been created.
Moving Averages
Most technical traders incorporate the power of various technical indicators, such as moving averages, to aid in predicting future short-term momentum. In fact, people who find it difficult to draw trendlines often will substitute them for moving averages. As you can see from the chart below, a moving average is a constantly changing line that smooths out past price data, allowing for an easier identification of support and resistance. Notice how the price of the asset in the chart below finds support at the moving average when the trend is up, and how it acts as resistance when the trend is down.
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Traders can use moving averages in a variety of ways, such as to anticipate moves to the upside when price lines cross above a key moving average, or to exit trades when the price drops below a moving average. Regardless of how the moving average is used, it often creates “automatic” support and resistance levels. Most traders will experiment with different time periods in their moving averages so that they can find the one that works best for their trading time frame.
Other Indicators
In technical analysis, many indicators have been developed and are still being developed to identify barriers to future price action. Some indicators are plotted on price charts, while others are plotted above or below the price. These indicators can often seem complicated at first, and it takes practice and experience to learn to use them effectively. But regardless of how complex an indicator appears, its use and interpretation are often no different from that of other indicators created through simpler methods like calculating moving averages and drawing trendlines.
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The “golden ratio” used in the Fibonacci sequence, is also observed repeatedly in nature and social structure.
For example, the Fibonacci retracement is a favorite tool among many short-term traders because it clearly identifies levels of potential support/resistance. The reasoning behind how this indicator calculates the various levels of support and resistance is beyond the scope of this article, but notice in the chart below how the identified levels (dotted lines) are barriers to the short-term direction of the price.
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Trading Ranges
Trading ranges can sometimes occur. These are areas where support and resistance levels are relatively close and the price bounces between two levels for a period of time. Experienced traders will sometimes trade within these trading ranges, which are also known as sideways trends. One strategy that they use is to place short trades as the price touches the upper trendline and long trades as the price reverses to touch the lower trendline. This strategy is extremely dangerous, and it is much better to wait to see in which direction the price will break out of the range and then place your trades in that direction.
Support and Resistance Reversals
A previous support level will sometimes become a resistance level when the price attempts to move back up, andconversely, a resistance level will become a support levelas the price temporarily falls back.
Price charts allow traders and investorsto visually identify areas of support and resistance, and they give clues regarding the significance of these price levels. More specifically, they look at:
Number of Touches
The more times that the price tests a support or resistance area, the more significant the level becomes. When prices keep bouncing off a support or resistance level, more buyers and sellers notice and will base trading decisions on these levels.
Preceding Price Move
Support and resistance zones are likely to be more significant when they are preceded by steep advances or declines. For example, a fast, steep advance or uptrend will be met with more competition and enthusiasmand may be halted by a more significant resistance level than a slow, steady advance. A slow advance may not attract as much attention. This is a good example of how market psychology drives technical indicators.
Volume at Certain Price Levels
The more buying and selling that has occurred at a particular price level, the stronger the support or resistance level is likely to be. This is because traders and investors remember these price levels and are apt to use them again. When strong activity occurs on high volume and the price drops, a lot of selling will likely occur when the price returns to that level, since people are far more comfortable closing out a trade at the breakeven point than at a loss.
Time
Support and resistance zones seen in longer time frame charts such as weekly or monthly charts are often more significant than those seen in shorter time frame charts such as the one-minute or five-minute chart.
Some investors dismiss support and resistance levels entirely because they say that the levels are based on past price moves, offering no real information about what will happen in the future. But all of technical analysis is based on using past price action to anticipate future price moves; therefore, this is an argument for dismissing technical analysis entirely.
How Can Identifying Support and Resistance Levels Help Traders?
Determining future levels of support can drastically improve the returns of a trading or short-term investing strategy because it gives traders an indication of where price declines are likely to halt. Conversely, foreseeing a level of resistance can be advantageous because it will alert traders to be vigilant as the price approaches this area for a likely reaction in price. As mentioned above, there are several different methods to choose when looking to identify support/resistance, but regardless of the method, the interpretation remains the same: The trader is looking for an indication that the price of a security will likely react in a certain manner as it approaches and touches a recognized price level.
How Can Market Psychology Influence Support and Resistance Levels?
Market psychology and behavioral finance can influence where support and resistance levels occur. Anchoring, for instance, is when people assign meaning or significance to otherwise arbitrary numbers. A previously established level of support or resistance may therefore become an anchor at which points future resistance or support will be observed - even though these points may not reflect any fundamentals. Likewise, round numbers such as $1,000 or $25,000 may serve as support or resistance levels, not because they are fundamentally-driven, but are symbolically meaningful as psychological anchors. As these levels are breached, traders mayadjust their anchorsaccordingly.
What Happens if a Price Breaks Through its Support or Reistance?
A breakout from a support or reversal can indicate a trend reversal. If support is broken, that will likely become the new level of resistance. Alternatively, if resistance is broken to the upside, it can form the basis for support in the short term.
The Bottom Line
Support and resistance levels are key concepts used by technical analysts and form the basis of a wide variety of technical analysis tools. The basics of support and resistance consist of a support level, which can be thought of as the floor under price, and a resistance level, which can be thought of as the ceiling above price. Prices fall and test the support level, which will either hold, and the price will reverse to the upside, or be violated, and the price will drop through the support and likely continue lowerto the next support level.
