One of the interesting phenomena of stock markets that tend to be catchy is the movement of stock prices at the blink of eyes. At one instant, you may find your portfolio in “green’ while in next couple of minutes it may turn “red”. This battle between bulls and bears may prove devastating for the traders if they do not exercise caution in tracking their stocks portfolio. While making a buy/sell decision of a specific stock, if you have ever got a chance to see the stock chart, there is a lesser probability that you haven’t come across “support” and “resistance” levels of the stock. What are support and resistance levels and how are these significant for stocks and for entire index in general is what we would see here!
Almost every stock has both a level of support and a level of resistance and usually it trades in this range bouncing between these levels. In very simpler words, Support level is the price where a falling stock finds its support and will not go down beyond this. Similarly, resistance level is the price level which a rising stocks finds difficult to overcome or cross. The definition here implicitly indicates its importance in buy/sell decision. Let’s understand in detail how??
For buyers; consider a share continuously moving down over a period of time and you find the fall in the price as a buying opportunity. To decide your entry price, support level is there to help you. Since the stock is unlikely to go below this level, you can opt to buy at this level without fearing any risk of further downfall and aiming to take an opportunity to buy.
For sellers; consider a share continuously moving up and your aim is to have maximum profit margin and take a profitable exit. Thus to decide upon an exit price, Resistance level is what you should look for. Since the stock is more likely to “bounce” off this level rather than breaking through it, you can sell your stock for better returns.
In generic terms, for a stock trading between support and resistance levels, the strategy of a trader should to buy a stock at support and sell at resistance. For traders involved in short selling short at resistance and then cover the short at support.
As a part of technical analysis there is no denying the fact that support and resistance can help you benchmark your decisions but it is very important not to assume that these levels will not breach at all.
It is likely that a declining stock breaches a support level and continues dropping until it finds another support level. This is called breakdown and usually occurs when number of Buyers willing to step in to buy exceeds the supply available from sellers willing to sell. On the similar note, a rising stock may also breach the resistance level and continue rising till it finds another resistance level. This occurs when the supply available from sellers willing to sell is greater then the demand from buyers willing to step in to buy. This is as simple as the concept of “demand and supply”. But next time you make a buy/sell decision, do take few minutes to have a look at these levels to enjoy its crunch.