Education: Supports and Resistances

Starting this week, we will see some of the important concepts that one need to learn to be a successful trader. We will start these with an article on the concept of supports and resistances

Supports and resistances offer important clues in technical analysis to figure out when to enter a stock and when to exit one. Typically, a break of support is a bearish signal and signals that one should exit a stock. A resistance break signals that the stock is poised to move up further. While these may not be the only signals based on which, one decides to enter or exit a stock, these are 2 very important pieces of information. Lets look a little deeper into these.

A support area is typically an area where demand is more than supply, thus it "supports" the stock from any fall in price. A "resistance" is a point where the supply is more than demand and hence the stock struggles to move up further. Analysts, use past data to figure out support and resistances for a particular stock.

An important point to note here is that, when a support is broken and the stock moves down, the same spot acts as a resistance at a later rally when the stock tries to move up. The converse applies for resistance. A broken resistance level acts as a support during a later correction.

The below chart shows data of SBI over a period of time. The horizontal red line indicates a price level where the demand-supply tug of war is maximum indicating presence of a support/resistance. Note how the stock has moved drastically on either side once the level has been taken out.



Determining support and resistances
Supports and resistances can be determined by drawing lines connecting any 2 points in a price chart. The more the number of points, the more it confirms the existence of a support/resistance area. When picking up points to draw your lines, you should look for key reversal areas in the chart.