What you should know about levels of resistance and support

We had learned about entry and stop loss points when talking about candlestick patterns. The goal price, nevertheless, was not brought up. The same will be covered in this chapter.

Finding the support and resistance levels is the most effective method of determining the goal price. On a chart, the support and resistance (S&R) are particular price points that are predicted to draw in the greatest amount of buying or selling. A price at which there are expected to be more buyers than sellers is known as the support price. In a similar vein, the resistance price is the point at which more sellers than buyers are likely to occur.

Traders can also use S&R independently to determine trading entry locations. 

The Resistance:

Resistance, as the name implies, is what prevents the price from increasing even higher. The resistance level is a position on the chart where traders anticipate the stock or index to see its highest supply (i.e., selling volume). The degree of resistance is consistently higher than the present market price.

There is a good chance that the price will rise to the resistance level, consolidate, take in all of the supply, and then decline. One of the most important technical analysis tools that traders consider in a rising market is the resistance. Usually, the resistance serves as a sell trigger.

This is Ambuja Cements Limited’s chart. The resistance level for Ambuja Cements is indicated by the horizontal line on the chart that coincides at Rs. 215.

I’ll give a brief explanation of why I purposefully shrunk the chart to fit in more data points. However, before you do anything, notice the following two points when examining the chart above:

  • A horizontal line represents the resistance level, which is higher than the current market price.
  • The current candle is at 206.75, while the resistance level is at 215. For your reference, the current candle and its matching price level are surrounded.

For the sake of illustration, let’s say that Ambuja Cement forms a bullish marubuzo at Rs. 206, with a low of 202. We are aware that the stop loss for this trade is at 202 and that this is a signal to open a long position. Now that we have a better understanding of resistance, we may potentially aim for 215 with this trade!

You may think, why 215? The explanations are straightforward:-

  • The probability of an excess supply is indicated by the resistance of 215.
  • Oversupply increases selling pressure.
  • There is usually selling pressure, which pulls prices down. 

For the above mentioned reasons, a long trader can use resistance points to determine goals and exit points.

Additionally, the resistance may now be identified, allowing the long trade to be fully structured as follows:

Target is 215, Entry is 206, and Stoploss is 202.

The obvious issue that follows is: How can we determine the resistance level? It’s very easy to determine whether price points are a support or resistance. The method of identification for resistance and support is the same. The detected position is referred to as a resistance point if the current market price is below it, and a support point otherwise.

Given that the steps are the same, let’s move on to comprehend “support” and then identify S&R using the same technique.

The Support:

Knowing about resistance will make determining the support level easy to understand. Support, as the term implies, is what keeps the price from dropping any lower. The support level is a price on the chart that represents the trader’s estimate of the greatest amount of buying demand for the stock or index. The price is probably going to rise again whenever it reaches the support line. The current market price is always higher than the support level.

The price has the greatest chance of falling to the support, consolidating, absorbing all of the demand, and then beginning to rise. In a declining market, one of the most important technical levels that traders search for is support. Support frequently serves as a catalyst for purchase.

This is Cipla Limited’s chart. The Cipla support level is indicated by the horizontal line on the chart that coincides at 435.

A few things to note about the above chart are:

  • The horizontal line represents the support level, which is below the current market price.
  • The current candle is at 442.5, while the support level is at 435. For your reference, the current candle and its matching price level are surrounded.

Let’s visualize a bearish pattern creation, such as a shooting star at 442 with a high of 446, much like we did when we understood resistance. With a shooting star, it is obvious that the call is overly short at 442, with 446 serving as the stop loss. We can set the aim at 435 because we know that 435 is the immediate support.

What then qualifies the Rs. 435 target? The choice is supported by the following factors:

  • Support at 435 suggests that the likelihood of surplus demand emerging is at its highest.
  • Oversupply increases purchasing pressure.
  • Price pressure from buyers typically pushes prices upward. 

For the previously mentioned reasons, a trader who is short can use support points to determine targets and exit points for the trade.

Additionally, the short trade is now fully structured with the support identified.

Target: 435, entry: 442, stoploss: 446. 

Building/Drawing the Level of Resistance and Support

This four-step method will assist you in determining and creating the resistance and support lines.

Step 1: Load data points. If determining short-term S&R is the goal, load data points spanning at least three to six months. Load data points spanning at least 12 to 18 months if you wish to find long-term S&R. The chart appears compressed when a lot of data points are loaded. This also explains the squished appearance of the two charts above.

  • Swing trading can benefit from long-term S&R.
  • Short-term S&R is helpful for BTST and intraday trading.

I’ve added data points from the last 12 months to this chart. 

Step 2: Determine a minimum of three price action zones. “Sticky points” on the chart where the price has exhibited at least one of the following behaviors are what define a price action zone:

  • Hesitated to ascend higher after making a quick upward move.
  • Hesitated to descend farther after making a quick downward move.
  • Abrupt turns around at a specific price

The following charts list the three points mentioned above in the same order:

The circular marks on the chart below show that after a quick up advance, the price is reluctant to climb higher: 

The chart below shows the price hesitating to proceed lower after a small decline, as indicated by the surrounding points:

The following chart’s encircled points show abrupt price reversals:

Step 3: Align the zones of price activity. A 12-month chart often has a large number of price action zones visible. Finding at least three price action zones at the same price level is the tricky part, though.

In this chart, for instance, two price action zones are distinguished, although they are not located at the same price.

Examine the chart below, where I’ve highlighted three price action zones that correspond to the identical points of sale:

Making sure that these price zones are appropriately spaced out in time is a crucial consideration when finding these price action zones. In other words, if the first price action zone is found around the second week of May, it will be significant to find the second price action zone at any time after the fourth week of May (appropriately spread out). The S&R identification is more potent the greater the gap between two price action zones.

Step 4: Fit a Horizontal Line: Make a horizontal line connecting the three price action zones. This line becomes support or resistance depending on how it fits into the current market price.

Examine the following chart.

Beginning on the left side:

  • The first circle indicates a region of price movement where there has been a significant price reversal.
  • A price action zone with sticky prices is shown by the second circle.
  • The third circle indicates a region of price movement where there has been a significant price reversal.
  • A price action zone with sticky prices is shown by the fourth circle.
  • The fifth circle displays Cipla’s current market price of 442.5. 

All four price action zones in the chart above are centered on the same price points, or 429. Since the horizontal line is obviously below the 442.5 market price, 429 represents an instant support level for Cipla.

Please be aware that there is an approximation risk associated with any visual exercise in technical analysis, such as detecting S&R. Thus, allow for mistake at all times. Typically, a range rather than a single price point is used to represent the price level. In actuality, it is a zone or an area that provides resistance or support.

Based on the reasoning presented above, I would be happy to consider a price range of 426 to 432 for Cipla as a support region. I simply took 429 and added 3 points to reach my price range for the support; there is no set rule for this range!

In the following chart, Ambuja Cements Limited’s S&R have been recognized.

Ambuja’s current price is 204.1; the resistance is located at 214 (above current market price), while the support is located at 201 (below current market price). Therefore, if Ambuja were oversold at 204, the objective may be at 201 depending on support. This would most likely be a profitable intraday trade. Based on resistance, 214 may be a reasonable target expectation for a trader who goes long at 204.

Observe that there are at least three distinct price action zones at the price level, all of which are evenly separated in time, in both the support and resistance levels.

Reliability of S&R

Only a potential price reversal is indicated by the support and resistance lines. They should never be taken for granted. Similar to anything else in technical analysis, one should consider the probability of an event occurring based on patterns.

For instance, according to Ambuja Cements’ chart –

The current market price is 204.

214 is the resistance. 

It is anticipated that resistance would likely arise at 214 if Ambuja Cement moves higher at all. In other words, at 214 sellers might show up and force the prices down. Is there a guarantee the sellers will arrive at 214? Stated otherwise, what is the resistance line’s dependence? To be honest, both your guess and mine are valid.

But historically, it is evident that Ambuja exhibited a strange reaction anytime it approached 214, which resulted in the creation of a price action zone. The price action zone’s good temporal spacing is reassuring in this situation. The price action zone with a mean of 214 has been examined throughout time. Therefore, we proceed with the assumption that support and resistance levels will be fairly honored while keeping in mind the very first technical analysis guideline, which is that “History tends to repeat itself.”

Based only on my own trading expertise, well-built S&R points are typically highly esteemed.

Optimization and checklist

We may have reached the most significant point of this module at this point. We’re going to begin learning some optimization strategies that will aid in locating quality transactions. Recall that achieving quality always comes at the expense of quantity, but this is a trade-off that is worthwhile. Finding high-quality trading signals is the goal, not finding lots of trades that are useless.

Generally speaking, optimization is the practice of fine-tuning a procedure to yield the optimum outcomes. In this case, the procedure involves figuring out transactions.

Let’s go back to the first candlestick pattern we learned, the bullish marubozu. When there is a bullish marubozu, it indicates a long trade close to the close, with the low of the marubozu serving as the stop loss.

Assume the bullish marubozu has the following qualifications:

Close = 448, Open = 432, High = 449, Low = 430

Thus, the long trade entry is about at 448, and the stop loss is at 430.

What happens, then, if the marubuzo’s low also happens to be a well-timed, tested support? Do you notice how these two technical notions remarkably coincide? 

To proceed, we have two confirmations. Consider it in terms of the following:

  • Bullish marubuzo, a well-known candlestick pattern, advises the trader to open a long position.
  • Support close to the stop-loss price indicates to the trader that there was a lot of interest in buying at the low.

A trader’s most important tool for navigating a chaotic environment like the markets is a well-designed trade setup. The same course of action—that is, to start a long trade in this instance—is suggested by the existence of the two circumstances mentioned above (marubuzo + support close to the low).

This brings us to a crucial concept. What if each deal we thought about had a checklist—you could even call it a framework—for each one? Before starting a trade, the checklist would serve as a guide. The trade needs to meet all of the requirements listed in the checklist. If so, we accept the trade; if not, we let it go and search for another opportunity to make a transaction that meets the requirements on the checklist.

It is said that discipline accounts for 80% of a trader’s performance. The checklist, in my opinion, makes you more disciplined and keeps you from making rash or careless trading decisions.

Actually, to start, we have the first two crucial elements listed on the checklist:

  • There should be a discernible candlestick pattern formed by the stock.
  • Note: This module has taught us a few of the more well-known patterns. Initially, you can utilize only these patterns to adhere to the checklist.
  • S&R needs to attest to the transaction. Approximately S&R should be the stop-loss price.
  • The pattern’s low point for a long trade should be close to the support.
  • The pattern’s peak should be around the resistance for a short trade.

We will develop this checklist when we come across new TA topics in this module. To pique your interest, there will be six checklist points in the final version. We will actually weigh each of the grand six checklist items once we acquire them. Point number 4 on the checklist, for instance, may not be as crucial as point number 1, but it still has greater significance than 100 other elements that could divert the trader’s attention.

Conclusion:

It is essential to comprehend and apply support and resistance (S&R) levels when trading in order to make wise choices. By assisting traders in determining possible entry and exit positions for their deals, these levels help them maximize profits and reduce risks. A price level known as resistance is where strong selling pressure is anticipated to keep the price from rising any higher. Support, on the other hand, is a price point at which additional price declines are unlikely due to expected purchasing pressure.

Traders can create S&R lines on their charts by studying past price action and pinpointing important areas where the market has exhibited hesitation or reversal. These lines are useful benchmarks for forecasting future price changes. S&R levels should, however, be utilized in conjunction with other technical analysis tools and market conditions as they are not infallible.

By including a checklist that covers important elements such identifiable candlestick patterns and S&R validation, traders can further refine their trading techniques. This methodical technique guarantees a greater likelihood of profitable trading and assists in preventing rash selections.

FAQ’s:

What role do levels of resistance and support have in trading?

In trading, support and resistance levels are important because they show possible price areas where there may be more buying or selling pressure on the market. These levels aid in risk management, realistic target price setting, and the identification of the best times to enter and exit the market.

How do traders determine levels of resistance and support?

By examining previous price action and identifying zones where the price has displayed pause, reversal, or considerable movement, traders can determine support and resistance levels. This entails looking for patterns in the charts, drawing horizontal lines at significant price points, and making sure these levels are spaced out properly over time.

Can levels of resistance and support fluctuate over time?

Indeed, when the dynamics of the market alter over time, support and resistance levels may also. Based on current market behavior, new levels may emerge and previous levels may become less important. Traders must constantly update their charts and modify their tactics as necessary.

How accurate are levels of resistance and support for forecasting future price movements?

Although they are useful instruments, support and resistance levels cannot always be used to forecast future market moves. To increase dependability, they should be used in conjunction with other technical indicators and market analysis, since they suggest possible zones of price reversal or consolidation.

What use does a checklist serve when trading with levels of support and resistance?

A checklist aids traders in upholding consistency and discipline in their approach to trading. Traders can decrease impulsive decisions and increase the possibility of profitable transactions by making sure that all requirements, such as the presence of a recognizable candlestick pattern and S&R validation, are met before executing a trade.

whatsapp