Support and Resistance

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In this section, we dig into the fundamental concepts of support and resistance and their influence on market dynamics. The price of any tradable asset, be it goods, services, or financial instruments, is determined by the interplay of supply and demand forces. This principle remains just as true in the world of investing and trading. When we invest in the financial market, the prices of shares and other assets are influenced by a myriad of factors, including company financials, macroeconomic news, and overall market sentiment. However, at its core, the essence of price movements can be traced back to two fundamental supply and demand, the principles of our modern economy.

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Demand is the quantity of a stock or asset required in the market and is the representation of the buyers or bulls. Supply is the amount of a stock or asset available in the market and and is a representation of the sellers or bears. When analyzing the behavior of stock prices, we observe a dynamic relation between buyers and sellers, which influences the market in various ways. Let's explore the different market scenarios and their driving forces in more detail. When the price of a stock begins to decline, it often attracts more buyers to the market, drawn by the perceived attractiveness of a lower price.

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This surge in demand leads to an increase in buying activity, pushing the price higher. As this upward momentum continues, we find ourselves in an uptrend situation, commonly known as a bull market. In this type of market, buyers are in control, driving prices higher as optimism and confidence prevail. However, as the price continues to rise, some buyers who have made profits may decide to sell their positions, leading to increased selling activity. Additionally, fewer new buyers may be willing to enter at the higher price levels.

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This shift in sentiment results in an eventual increase in supply, leading to a reversal of the uptrend and the start of a downtrend, known as a bear market. In this scenario, sellers are in control and prices begin to decline. There is also a third type of market, known as a sideways or horizontal trend. In this situation, buyers and sellers find a balance and the price fluctuates within a defined range. This equilibrium can persist until new developments or catalysts disrupt the balance, tilting the scale in favor of either buyers or sellers, leading to a resumption of an up or down trend.

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Throughout these market movements, the strength of supply and demand serves as the driving force. As traders and investors, understanding these dynamics can help make better decisions. In technical analysis, the concepts of supply and demand are managed with the use of the tools of support and resistance levels. Support and resistance levels play an important role, helping traders in identifying key price zones where supply and demand converge. Support represents a price level where buying interest tends to be concentrated, creating a floor beneath the asset's price and preventing further decline.

[00:03:16.02] - Speaker 1
On the other hand, resistance represents a price level where selling pressure typically intensifies, capping the asset's price from further upward movement. These levels of support and resistance are key in understanding market sentiment as they reflect the collective decisions and actions of traders and investors. When an asset's price breaks above a significant resistance level, it often signals a bullish sentiment and the potential for further gains. When an asset's price breaks below a crucial support level may indicate bearish sentiment, signaling the possibility of further price declines. Let's look at an example.

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Support is that price level at which there is usually a halt in the downward trend of a securities prices. The price that is in a downtrend or sideways phase stops at these support areas. Buyers find the price of an asset very attractive at these levels and start buying again. As demand increases, the stock price starts to rise again. In this example, you see the support level drawn on the chart for this stock.

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As you can see, the price stops around the support levels to start its uptrend again. The resistance, on the other hand, is that price level where the growth of the price of a security stops. In the case of resistance, the price comes from an uptrend situation and more sellers enter the market. The supply of the security increases and the price tends to stop in these resistance areas. Supports and resistances are key markers on a price chart that signify the dynamic interaction between supply and demand.

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Another key concept in trading is the breakout. A breakout is a major event and represents price action that breaks a support or resistance level. If the price breaks the upward resistance, it means that more buyers are willing to buy at higher prices than the current ones. If the price breaks the support, it means that a greater number of sellers are willing to sell at lower prices than the current ones. When a support level is broken and the price moves below it, the support level, which once provided a floor for the price, now becomes the new resistance level.

[00:05:26.22] - Speaker 1
It acts as a barrier preventing the price from going above it. When a resistance level is broken, this will become the new support. These dynamics are the reflection of the psychology of market participants. When the price moves around these areas, there is typically a surge in activity as traders and investors recall the past price action and react to it. It is at these moments of breakout and retest that traders carefully observe price action, volume and other technical indicators to make decisions.

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Volumes are higher when the price moves back into these areas. Now let's do some examples using the TradingView platform. Support and resistance Levels are typically plotted across horizontal lines in the chart. Trend lines or channels also represent support and resistance levels. Breaking these levels represents an important event in a stock's price action.

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Think of these levels as price barriers. Let's look at this example of the S&P 500 index. The price does not always move in one direction. It tends to swing and change direction when it reaches support and resistance points. As in this example, we can identify points of maximum and minimum during the course of the trend.

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To draw support and resistance levels, we must first look at the stock's long term price action. This can help us see points of interest much more clearly. To do this, we can use TradingView and change the time window or use the zoom in and out functionality of the platform. We can connect price levels by drawing horizontal lines. The green lines represent the support levels and the red lines the resistance levels.

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Here we can see the Menthor Q momentum indicator. This indicator automatically draws support and resistance level and it is available within the premium membership. An important rule for identifying support and resistance points of interest is the number of times the level has been touched. Remember that the price action of a stock is represented by the action of buyers and sellers. The support and resistance levels help us understand points where the price can no longer go down and points where the price struggles to reach new highs.

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Now let's do some more examples. Another key point is the concept of support and resistance areas or zones. When we do an analysis on a security, we always try to identify what is called an area or zone of support or resistance. The reason is very simple. It can happen that during a period of indecision, supply and demand move around defined levels.

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But this clash causes movements that deviate slightly from the support or resistance price. This does not mean that the signal is wrong. Let's consider an example. In this case, we can identify multiple points of support. As you observe, the price reacts to these levels, but not necessarily with pinpoint accuracy.

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It is important to recognize that support and resistance lines are not always rigid and exact. For this, we always use the support and resistance areas or zones. Using areas instead of exact points helps us get more effective signals. Let's look at some other examples. In this example, we use the stock under Armor.

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We can locate the key levels in the graph. As we can see, we can spot important support and resistance areas. The bottom green line represents long term support. In March 2020, the stock collapsed, but the price stopped around the minimum level of 2012. The stock price then continues to rise, reaching new highs, but fails to break the resistance areas.

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And these levels are touched on multiple occasions. Then as we see a breakout to the upside, we can see the formation of a new uptrend. Now let's look at what happens when the price breaks support and resistance let's look at this example on Google stock. The first green rectangle represents a support area. It is touched upon several times.

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The price then reaches a high point outlined by the first red X. The price fails to reach higher highs beyond this point. This causes the price to fall towards the support zone. At that level the price fails to break down and starts to rise again in the direction of the primary trend reaching again the resistance zone. The first white circle represents a major breakout point of the previous resistance level.

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When this happens, the old resistance becomes the new support. We are now moving to a new trading range. Finally we see a new upward growth and the formation of a new resistance area and a second breakout to the upside. In the next lessons we will look at more examples on how to use indicators and support and resistance for our trading.