Level Des
Level Des
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How are Support and Resistance Levels Formed?
Support and resistance levels are perhaps the most widely followed technical analysis indicators by any type of trader or investor. They are also considered as one of the most reliable indicators to predict market trends and to place stop-loss and profit taking orders.
Support is the price level of an instrument on or below the current price level that act as a barrier for downward movement of price. Resistance is the price level of an instrument on or above the current price level that act as a barrier for upward movement of price. Support and resistance levels are identified from past price movements or the instrument; they are the past price levels where the prices have stabilized. There are many reasons for this price stabilization.
Reasons for formations of support and resistance levels.
- Buying and selling pressure: These are the most basic causes of resistance and support level formation. Very often, most traders try to buy stocks (or other instruments) when they fall by certain price causing the formation of a support level and most traders try to sell stocks when they rise by certain price. Automated trading systems which generate buy and sell signals enhance this phenomenon.
- Round price levels: At certain price levels like $80 or $100, there can be more traders willing to buy or sell a stock. Thus making this price level a support or resistance level for that equity.
- Market trends: In an upward moving market breaching of one resistance level will boost the confidence of buyers are and they will be ready to buy stocks at higher price levels, forming new resistance levels. Similarly in a downward moving market breaching of a support level boost confidence of sellers and a new resistance level is formed at lower price levels.
- Fibonacci techniques: Fibonacci techniques (eg: Fibonacci arc, fans, retracements, channels, time zones, extensions and clusters) are the most widely used tools for predicting future support and resistance levels. This widespread use followed by widespread entering of buy and sell orders at these levels has resulted in transformation of these price levels into support and resistance levels.
- Other technical indicators: Like Stochastic, RSI and moving averages for entering buy and sell orders helped in formation of support and resistance levels.
The strength of a support or resistance level is inversely proportional to how many times it is breached and directly proportional to how many times the price touched it. The strength of a support or resistance level increases in order of single (s) levels – price touched only once, double (d) levels – price touched twice, triple (t) levels – price touched trice, and More than triple (T+) levels – price touched many times.
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