Primer On Support And Resistance Levels

Finding and updating support and resistance levels is one of the primary jobs that technical analysts do. A support level (SL) is the cost at which securities that are dropping in value are expected to bounce back. A resistance level (RL) is the reverse, and is the expected price where securities climbing up hit a ceiling and are unable to climb further.

Why each stock has these support and resistance levels and the way to figure out them is really a complex subject that's made harder by the fact that these markers tend to shift over time. Let's try a straightforward explanation initial involving investor psychology, just before obtaining to the technical jargon. Assume that an investor buys a share for $100.

Let's say the share climbs up to $120 but just before the investor can offload the share, it drops back down to $110. Now it starts going up once more, and when it reaches $120 the investor has to contemplate whether it is going to drop back down and if so, wouldn't it be better to offload it before it drops? Since a whole lot of people face the exact same issue and actually do offload it at $120, the price drops once more.

This type of self-fulfilling herd mentality by investors ensures that each and every time the stock nears $120, there will be rush to the exits and also the stock will drop. This is referred to as a resistance level. The same principle applies for stocks on their method to the bottom. Once a stock bounces back up at a particular price (like $110 within the above example), it becomes a support level in future where investors searching for value step in and also the stock starts rising.

This is a extremely fundamental reasoning, as well as the reality is a lot a lot more complex. You will find other things that have to be factored in, such as a round number. For example, a stock priced at $48 and trending upward is likely to discover an RL at $50. It is human nature to prefer numbers like $50 rather than $49 or $50.2 or $50.8, so the RL is usually going to be $50 when the stock is anywhere close to it.

There are also proactive methods to figure out what the future SL & RL is going to be. If the long-term forecast for a stock is favorable, it tends to crack past the RL eventually and climb up to the next one. This next RL or SL can be predicted using methods like trendlines and calculated pivots.

Another factor to think about is that once a stock moves on to the next RL or SL, the previous one becomes the opposite. For example, if a stock cracks past a $50 RL and moves up to $55, then the $50 level becomes an SL for the stock. By the same token, if a stock drops down below the $50 SL to $45, then the $50 level becomes its RL. There's a great deal a lot more to support and resistance levels, but this should be enough to get readers hooked on this really interesting topic.