What are Supports and Resistances? And How to identify them?

By Trader Pit

July 8, 2021


Support : To identify a stock that is showing support over a specified period of time. Resistance : To identify a stock that is showing resistance over a specified period of time.

The final stage of any investment is to sell your holdings. This is a very difficult decision to make, since you may end up abandoning many years of hard work, valuable lessons and profits. To make things even more difficult, you may not be sure what you should sell, which stocks have the best prospects, or find yourself faced with stock market jargon that leaves you wondering if you should continue investing in an equity or a bond. The kind of service I propose is to help you understand the fundamental tools that are used to analyze the market and make the best decision possible.

Understand what support and resistance are: One of the most fundamental concepts in stock trading that every trader should know is support and resistance. If you are already in the market, you may have heard or read terms like Nifty50 has major resistance at 10,800 pips or XYZ stock has a support line at Rs 105. What exactly do traders mean by these terms in their analysis? We will discuss this in this article.

In this article we will look at what support and resistance are, what their properties are and how exactly you should use them. By the end of this article, you will have a good understanding of these concepts and be able to apply them to your trading. Let’s get started.

What is support and resistance?

A synonym for the word support is reinforcement.  In principle, one could say that aid is a point of reinforcement. In other words, support points are the points that act as a barrier to prices when they begin to fall. They can also be described as points where a break in the downward trend can be expected. And we should see a further increase in buying and demand. In short, pillars are those where buyers are more powerful than sellers.

On the other hand, resistance occurs when supply increases or buyers begin to withdraw their positions from the market. Therefore, after a thorough analysis, we can say that support and resistance are points of friction or struggle between buyers and sellers. And resistance is the area where sellers have a better chance than buyers.

Once the support and resistance (S&R) levels are determined, they become an entry or exit point for the trade. Prices rebound or correct from S&R levels, or break through those levels and move to the next S&R.

Supporting element

These are the main features of the supports, if you look at the charts:

  • Supports are points or levels below which it is difficult for the market to move. There is also a stumbling block between buyers and sellers.
  • The supports are also the point of maximum buyer demand, and even sellers are getting out of their short positions in the market.
  • Buyers have more say in determining market support levels. We can also say that these values are reference points for buyers.
  • When a support level is broken, the market quickly sells and the next support level is challenged.
  • If market support levels persist, new long trades can be initiated, and these trades generally have a good risk-benefit ratio.

– Understanding support by example

The figure below shows the daily chart of HDFC Bank. On this chart we get a clear representation of the concept of supports and the impact on the market when supports are reached or broken.

Figure 1: Daily chart of HDFC Bank (Source – Kite Zerodha)

Looking closely now, the market finds very strong support in the range of Rs 1030 to Rs 1075. Sellers are constantly trying to break through these levels, but to no avail. And once the foundation is formed at these levels, the market begins to grow.

And we see continued buying momentum in HDFC Bank’s share price. The trend support line is formed in the market by connecting three points from which the market rebounds. During this rally, HDFC Bank’s share price rose from 1030 to almost 1250 (a gain of almost 20%).

Once HDFC Bank’s share price breaks through trendline support, we see selling pressure increase and long positions exit the market. The stock price then reaches the initial support levels near the dotted lines (Figure 1). And once the market finds support at those levels, it starts to rise and we see continued buying in the market, and from there it makes a move of almost 25%.

So, if we only used simple support models in our trades on the chart above, we would get at least three trades with returns of at least 15%.

Resistance characteristic

Here are the basic characteristics of resistors using the diagrams:

  • Resistances are levels that the seller defends. And it’s hard for the market to rise above that level. It’s a battleground between buyers and sellers.
  • Maximum selling pressure is coming from sellers at this time and even buyers are starting to exit their long positions at these levels.
  • If the market breaks through the resistance levels, we could see massive short covering in the market until the next resistance levels.
  • Resistance can also be described as points where new short positions can be opened in the market, with a good risk-benefit ratio.

– Understanding resistors through examples

The above chart shows a weekly chart of Airtel Limited. This diagram gives us a clear illustration of the concept of resistance and the consequences for the market in the event of penetration.

Figure 2: Airtel’s weekly schedule (Source – Kite Zerodha)

The share price of Airtel Limited reached a new high in 2007, after which the market corrected by almost 50% from the high point. Again, the market rose to the 500 level and then began to correct again. And by connecting these two points, the initial top and the recent top, we can form a trend line.

So this trend line is now an important resistance in the market. As the market began to rise, this trend line acted as a major barrier and the market began to correct. And the market was able to break through that resistance in mid-2014, and the stock went into massive short covering. And the market moved towards the initial highs of the 570 level. So it is the strength of resistance when a key level is broken.

 

Short note
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Now let’s understand the concept of swing trading. Looking at Figure 2, we see a pronounced swing trade. Swing trades are trades that we hold for a longer period of time, usually until a full cycle is completed. These are the transactions that have a longer detention period. And usually we don’t have a profit target, we just follow the stop loss and go with the flow.

Watch this video to better understand the concept of supports and resistances:

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Final thoughts

In this article we have tried to simplify the concept of support and resistance when viewing charts. Let’s briefly summarize what we discussed today.

Support and resistance are important points on the charts to get good entry or exit points for our trades. On one side support is defended by bulls/buyers, on the other side resistance is defended by bears/sellers. These support and resistance levels can be used both to set price targets and to maintain stop losses for existing trades. As a general rule, you should aim for the closest resistance level when trading long term. Instead, look for the closest support level as a target for a short trade.

Hitesh Singhi is an active derivatives trader with over 10 years of experience in trading futures and options on Indian equities and international energy commodities like Brent, WTI, RBOB, gasoline etc. He has traded on BSE, NSE, ICE and NYMEX. Hitesh’s credits include a degree in business management and an MBA in finance. Follow Hitesh here on Twitter!

Frequently Asked Questions

How do you identify support and resistance?

Support and resistance are two levels of price that define the price range for the asset. Support is the level that the price of the asset will not drop below, and resistance is the level that the price of the asset will not rise above.

What are the different types of support and resistance?

Support and resistance are two terms that are used to describe the price levels of an asset or market. Support is the price level at which the price of an asset or market is expected to rebound. Resistance is the price level at which the price of an asset or market is expected to decline.

How do you use a support and resistance indicator?

A support and resistance indicator is a technical indicator that is used to determine the price range of a security. It is a line that is plotted on a chart that is used to indicate the price range of a security.

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About the author

Trader Pit

A yogi who like Finance and Technology. I have been in Indian Stock market for over 12 years now as financial analyst, portfolio manager, trader. Now, I focus on Yoga, Financial Education & Long term investing. 

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