Introduction to Support and Resistance

Support refers to a price level where buying interest is strong enough to prevent the decline in an asset's price, while resistance refers to a price level where selling pressure is strong enough to stop the asset's price from rising further. The strength of these levels is determined by the number of times the price has bounced off that level and the volume of trading activity at that level.

Support levels indicate the price at which the majority of investors believe that prices will move higher, while resistance levels indicate the price at which the majority of investors feel prices will move lower. However, investor expectations change, and abrupt changes often result in shifts of support and resistance levels. The development of these levels is the most noticeable and recurring event on price charts.

Support is usually established below the current price, but it is not uncommon for a security to trade at or near support. Once support is broken, another support level will have to be established at a lower level. Resistance is usually established above the current price, and a break above resistance signals that the bulls have won out over the bears. Resistance levels can be volatile, and some traders and investors establish resistance zones.

The foundation of most technical analysis tools is rooted in the concept of supply and demand. Charts of market prices show the quantity of sellers and buyers at a given price, and as investor expectations change, the prices buyers and sellers feel are acceptable also change. A breakout above a resistance level is evidence of an upward shift in the demand line as more buyers become willing to buy at higher prices, while the failure of a support level shows that the supply line has shifted downward.

There are different types of support and resistance, including horizontal, diagonal, and dynamic. Horizontal support and resistance levels are the most common type, and they are established when prices bounce off a certain price level repeatedly. Diagonal support and resistance levels are established when the price moves in a diagonal line, and dynamic support and resistance levels are established by technical indicators that help traders identify changes in supply and demand.

Overall, understanding support and resistance levels is crucial in trading as it can help traders make informed decisions on when to enter or exit a position, set stop-loss orders, and take profits. By analyzing price charts, traders can identify the strength and location of support and resistance levels and use this information to determine potential price movements.