There are two variations to support and resistance. The first is a level, which consists of a generally specific price that support and resistance takes effect. The second is a zone, which is a general area or chart region that support or resistance take effect.
A resistance level or zone halts price increases due to supply entering the market. When price increases to a resistance level or zone, market participants enter the market by selling off asset inventory. This balance in supply and demand halts further increases.
If supply exceeds demand, the price will reverse and begin to move downwards. In a steady uptrend resistance levels are exceeded. This is often due to deteriorating fundamentals, future uncertainty, bad news, or reduced future earnings expectations.
Psychology of Support & Resistance
Support and Resistance only indicate historically probable halting points to trending price movements. Each one is based on the likely actions groups of investors will take at those points if the current underlying fundamentals remain generally constant. Note that both concepts are really a psychological measure. They’re rooted in the idea that an asset’s market participants will take a certain action at a price point. If they no longer have a reason to take that action, the support or resistance level will fail, and price will continue to trend past the support or resistance level. Neither specifically guarantees a price reversal, but you may see more reversal patterns form at these points.
Due to human tendencies to attach psychological significance to numbers, support and resistance levels typically are mentally favored numbers. Round numbers, multiples of 5, 10, 25, 100, and 1,000 are common favorites. Fibonacci retracement levels are also favored places for previous retracement points, since they feature percentage based retracement moves. Some proportional Fibonacci numbers are 33%, 50%, and 66%.
Understanding how market participants mentally prioritize support and resistance levels or zones is important. They are not all equally important. The general prioritization system is based on time, trend strength diverted, and volume.
For time, the longer a support or resistance level has existed, the greater its importance. If a support or resistance has regularly existed for 20 years on a monthly chart, it will be seen as more important than a level that has existed for 20 minutes on an intraday chart.
For trend strength, the stronger the trend diverted, the more important the support or resistance. If a slightly sloping trend was diverted, this support or resistance is less significant than zones which diverts a steep trend. In the eyes of traders, levels or zones which divert steep trends mean significantly more for underlying fundamental reasons.
In terms of volume, the more an asset trades hands at a significant fundamental level, the more significant the support or resistance zone. If twenty million contracts change hands at a level, it has greater implications than two hundred shares changing hands at that level. Higher volumes have more psychological impact on buyers and sellers transacting at that point, and thus more market significance.
Trends versus Support & Resistance Levels
Trends interplay with support and resistance. In an uptrend, support levels will be rising while resistance levels are consistently shattered, sometimes by an upwards gap. If a support level is broken, the uptrend is probably consolidating into a sideways pattern or reversing. In downtrends, each resistance level will be falling while support levels are consistently shattered. When resistance levels are broken, the downtrend is probably consolidating or reversing.
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