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Support Resist Transformation

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A previous support level that is broken can become a new resistance level. The same is true in reverse, a previous resistance level that is broken can become a new support level. These occur on a fundamental and psychological level.

A resistance or support level is perceived as a price limitation due to reasons related to fundamentals or future earnings expectations generally indicating a range of security value. Once those reasons change, price moves beyond the support or resistance level of that range. A return to that range is unlikely without an underlying change in fundamentals or the way they are perceived in the marketplace allowing price to return. As a result, the old resistance levels are reasonable places to expect support if price moved upwards. If price moved downwards, the old support levels are reasonable places to expect resistance.

Trader’s psychology also plays a role in turning support into resistance levels, specifically regret. Many market participants feel regret when they miss their entries or their exits during uptrends or downtrends. In an uptrend, people who miss their entry when a resistance level is broken are forced to purchase entries at a more expensive point. If the price falls to the old resistance level, they can purchase their entry cheaper. Participants who opened short sale positions regret the losses they are suffering and can buy shares to close out cheaply at returns to the resistance level and avoid greater losses. The people who closed their long positions earlier wish they had held those positions. The people who opened long positions often wish they had bigger sizing. The purchases from all four groups add demand to the price level, raise the price away from the old resistance level, and turn the old resistance level into a support level.

When support is broken in a downtrend, those who missed their entry wish they had opened positions when the price was higher. The short sellers wish they had opened larger positions before the price decreases began. Traders who liquidated their positions wish they had held their short sales. When price returns to the support level, all three groups can cheaply open new short positions. Finally, the long buyers who wish they hadn’t purchased securities can exit with cheaper losses. A return to support is their opportunity to exit losing positions cheaply. Sales from all four groups raise volume on the supply side and create downward price pressure, which turns support into resistance.

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