The price of financial assets is determined by the forces of supply and demand, just like in any other commercial market. In financial markets, it is support and resistance levels that accurately illustrate how the forces of supply and demand interact to determine the prevailing price of an underlying asset.
Prices usually rise until supply exceeds demand and that is the resistance point, where prices will start to decline. Similarly, prices will fall until demand exceeds supply and that is the fulcrum, where prices will start to rise.
The basic strategy in the market is to buy an asset when prices are at the support level and sell when prices are at the resistance level.
It is important to note that support and resistance levels are not exact price points, but areas where supply and demand can change. Support and resistance levels are closely monitored by market participants, who are eager to seize opportunities that may arise when supply or demand changes.
- Technical analysts use support and resistance levels to identify price points on a chart where probabilities favor a pause or reversal of a prevailing trend.
- Support occurs where a downtrend is expected to stop due to a concentration in demand.
- Resistance occurs when an uptrend is expected to stop temporarily due to a concentration of supply.
- Market psychology plays an important role as traders and investors remember the past and react to changing conditions to anticipate future market movements.
- Support and resistance areas can be identified on charts using trend lines and moving averages.
Types of Support and Resistance
- Fixed Support and Resistance Levels
These are support and resistance levels that are fixed and cannot change. They will only be invalidated if the prices manage to exceed or exceed them. Psychological and sentimental levels, such as round numbers or previous important price points (such as all-time highs and lows), are examples of fixed support and resistance levels.
2. Dynamic Support and Resistance Levels
As the name suggests, these are support and resistance levels that change as price and time change. These levels imply that prices are subject to new forces of supply and demand. Technical indicators like the moving average and the Bollinger band create dynamic levels of support and resistance as price and time change.
3. Semi Dynamic Support and Resistance Levels
Semi-dynamic support and resistance levels also change as time and price change, but they change at a fixed or predetermined rate. Some of the indicators that draw resistance lines and semi-dynamic support are trend lines, pivot points. These indicators draw support and resistance lines that change methodically as time and price change.
Support and resistance levels are one of the key concepts used by technical analysts and form the basis for a wide variety of technical analysis tools. The basic concepts of support and resistance consist of a support level, which can be thought of as the bottom under trading prices, and a resistance level, which can be thought of as the top. Prices drop and test the support level, which will either “hold” and the price will rebound, or the support level will be violated, and the price will fall through the support and will likely continue lower to the next support level.
Determining future support levels can dramatically improve the returns of a short-term investment strategy because it gives traders an accurate picture of what price levels should prop up the price of a given security in the event of a correction. Conversely, anticipating a resistance level can be advantageous because this is a price level that could potentially damage a long position, which means an area where investors are highly willing to sell the security. As mentioned above, there are several different methods to choose from when looking to identify support-resistance, but regardless of the method, the interpretation remains the same: it prevents the price of an underlying asset from moving in a certain direction.