What is support and resistance?

Support and resistance levels are critical junctures where the dynamics of supply and demand converge. Technical analysts regard these levels as pivotal in assessing market psychology and the balance between supply and demand. When these levels are breached, it signifies a shift in the underlying forces that originally defined them. Consequently, new support and resistance levels are anticipated to emerge as market conditions adjust.

Support

Support is the price level at which demand is sufficiently strong to prevent a stock from declining further. As illustrated above, each time the price nears the support level, it encounters resistance to further downward movement. This is because buyers, sensing value at lower prices, become more eager to purchase, while sellers, discouraged by lower prices, are less willing to sell.

Resistance

Resistance, on the other hand, represents the price level at which supply is robust enough to prevent a stock from advancing further. In the depicted scenario, whenever the price approaches the resistance level, it struggles to ascend. This occurs because sellers, anticipating profit-taking opportunities, become more inclined to sell at higher prices, while buyers, discouraged by higher prices, are less motivated to buy.

Support and resistance role reversal

A key concept of technical analysis is that when a resistance or support level is broken, its role is reversed. If the price falls below a support level, that level will become resistance. If the price rises above a resistance level, it will often become support. As the price moves past a level of support or resistance, it is thought that supply and demand has shifted, causing the breached level to reverse its role.

Support to Resistance Role Reversal:

Definition: A support level that has been breached and subsequently becomes a resistance level.
Reason: When a support level is broken, it indicates a shift in market sentiment from bullish to bearish. Traders who previously relied on this level to buy now see it as a potential barrier to further upside. Therefore, when the price attempts to rise back to this level, these traders may sell, creating resistance.
Example: If a stock's price breaks below a support level at $50, it may later struggle to rise above $50 as traders who bought at $50 may now sell to cut losses or lock in gains.

Resistance to Support Role Reversal:

Definition: A resistance level that has been breached and subsequently becomes a support level.
Reason: When a resistance level is broken, it signals a shift in market sentiment from bearish to bullish. Traders who previously sold at this level now see it as a potential support where buying interest may emerge. Therefore, when the price retraces back to this level, these traders may buy, providing support.
Example: If a stock's price breaks above a resistance level at $70, it may later find support around $70 as traders who sold at $70 may now buy on pullbacks to this level.

In essence, support and resistance role reversals highlight the dynamic nature of market psychology and the evolving balance between supply and demand. These reversals are key concepts in technical analysis, influencing traders' decisions and market behavior.

How can market psychology influence support and resistance levels?

Market psychology and behavioral finance play crucial roles in shaping the locations of support and resistance levels in financial markets. Anchoring is a psychological phenomenon where individuals assign significance to specific price levels based on past experiences or perceived importance, rather than purely on fundamental factors. Once a support or resistance level is established and recognized by market participants, it can act as a psychological anchor. Traders often refer back to these levels when making trading decisions, expecting similar price reactions as in the past.

Round numbers, such as $1,000 or $25,000, exemplify another aspect of psychological anchors in trading. These levels do not necessarily derive their importance from underlying economic data but rather from their symbolic meaning and ease of recognition. Traders tend to pay attention to these round numbers because they represent milestones or benchmarks in market sentiment.

Conclusion:

Support and resistance levels are identifiable across various charting timeframes, including daily, weekly, and monthly intervals. Traders also pinpoint these levels on smaller timeframes like one-minute and five-minute charts. However, the significance of support and resistance tends to increase with longer time periods.

To identify support or resistance, traders typically examine historical price movements to identify significant pauses during price declines or rises. These pauses indicate potential support (during declines) or resistance (during rises) levels. Traders then observe how prices behave as they approach these identified levels in the future.

Experienced traders often monitor past support or resistance levels closely because these levels can influence future price action. They may enter trades in anticipation of a repeat reaction at these levels, either expecting a bounce (at support) or a pullback (at resistance). This approach is rooted in the belief that historical price behaviors often repeat themselves due to market psychology and the collective actions of market participants.

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.