WHAT IS SUPPORT AND RESISTANCE
In real world, there is nothing such as the Support and resistance, These are imaginary areas plotted on the charts which depicts that prices were not able to pass through these levels due to the balancing of buy and sell trends, But when these levels are cracked prices move vigorously and cause many smaller market participants to be kicked out of the market.
Support and resistance are the next major concept after understanding the concept of a trend. You’ll often hear technical analysts talk about the ongoing battle between bulls and bears, or the struggle between buyers (demand) and sellers (supply). The proverbial ‘battle lines’ can be defined as the support and resistance levels where the most trading occurs. Support levels are where demand is perceived to be strong enough to prevent the price from falling further, while resistance levels are prices where selling is thought to be strong enough to prevent prices from rising higher.
Support and resistance levels are psychologically-important levels where a lot of buyers and/or sellers are willing to trade the stock. When the trendlines are broken, the market psychology shifts and new levels of support and resistance are established.
Importance of Support and Resistance
Support and resistance levels are a critical part of trend analysis because it can be used to make specific trading decisions and identify when a trend is about to reverse. For example, a trader might identify an upcoming support level and decide to start buying the stock as it approaches knowing that it will likely rebound higher. These levels both test and confirm trends and should be closely monitored by anyone using technical analysis. As long as the price remains between these two levels, the trend is likely to continue in the prevailing direction.
However, a break beyond support or resistance does not always indicate a reversal. For example, a breakout higher may be the start of a faster bullish trend and vice versa for a breakdown below trendline support. There are also instance of ‘false breakouts’ when a price may breakout higher on low volume and then fall back into a price channel.
Traders should be aware of support and resistance levels and avoid placing orders at these major points since they’re usually characterized by a lot of volatility. If you feel confident about making a trade near these levels, it’s important to avoid placing orders directly at the level since they are rarely reached. This is because the price never actually reaches the whole number, but rather, flirts with the levels before rebounding. Traders may also place stops or short selling orders around these levels to capitalize on a breakdown or breakout.
NUMERICAL WAY TO CALCULATE SUPPORT AND RESISTANCE
There are many ways to calculate levels of support and resistance (Pivot point method, Moving averages, Fibonacci numbers etc). One of the most common is to use a series of formulas to calculate “pivot points”, described herein
Calculate the pivot point as follows, using the previous day’s high, low, and close:
Pivot or P = (High + Low + Close) / 3
Calculate the first support point (S1) = (P x 2) – H
Calculate the second support point (S2) = P – (High – Low)
Calculate the first resistance point (R1) = (P x 2) – Low
Calculate the second resistance point( R2) = P + (High – Low)
Many traders adjust their value for P as follows:
O = Today’s Opening Price
P = O + (H + L + C) / 4 (where H, L & C are from the previous day’s stock details)