Support and resistance levels form the bedrock of technical analysis. Every pattern and figure on price charts is a unique combination of support and resistance levels.

Every trader uses these levels in their trading. The primary task for all newcomers to stock trading will be to fully study these levels. In this article, you’ll learn what support and resistance levels are and all the principles of their construction.

Basic Information

You could say that support and resistance levels represent the confrontation between bears (sellers) and bulls (buyers) on a chart. Bears push prices down, while bulls push them up. Essentially, the outcome of the confrontation is determined by which direction the price will move.

Support is the level at which buyers will control prices and prevent them from decreasing in the future. Resistance, on the other hand, is the level at which prices are controlled by sellers. The support level reflects the price at which investors anticipate an increase, while the resistance level represents the price at which investors expect a decrease.

How to Determine Trend Strength

Levels are excellent for determining trends and their strength.

A trend is a visible rise or fall in price. Trends can be either descending or ascending. In an ascending trend, there is a sequential increase in minimums, while a descending trend features a sequential decrease in maximums. A maximum is a short-term shift from an ascending to a descending trend that can be visually identified. A minimum is a short-term shift from a descending trend to an ascending one, also visually identifiable.

Thus, you can determine trend strength using resistance and support levels. For example, if you notice an ascending trend coming very close to a resistance level, then retracing, and finally breaking through it, you should definitely consider buying. This trend is strong and the value of its assets is likely to increase.

The same system applies for a descending trend. If it breaks the support level on the second or third attempt, it’s time to sell quickly. This trend is also strong, and the value is expected to decrease.

Supply and Demand

To identify supply and demand, it’s also essential to use resistance and support levels. Let’s delve into their principles of operation.

From the early stages of learning economics in school or university, we were taught about levels of supply and demand. Demand levels indicate the volume of a financial instrument that bulls are ready to buy at a certain price. However, as the price rises, the number of potential buyers gradually drops. Supply levels indicate the volume of “goods” that bears are ready to sell at a certain cost. An increase in cost will provoke an increase in the number of sellers.

Supply and demand levels show the number of sellers and buyers prepared to transact at a particular price. These levels will constantly shift in a free market. This shift is influenced by investors’ expectations, which alter the prices acceptable to buyers and sellers.

When a resistance level is breached, demand shifts upwards. This means that the number of people willing to buy at a higher price is increasing. When a support level is breached, supply shifts downwards.

Trader’s Thoughts

Usually, after a resistance or support level is breached, traders ponder whether the new prices are fair. If the cost seems unjust, they start selling or buying. Everything will depend on which level is breached. In some cases, it may be the opposite; traders may accept the new price, and it will continue to move in the direction of the breach.

In the first case, a sudden “bull trap” appears, and in the second case, a “bear trap.”

From Resistance to Support

If a resistance level is successfully breached, it transforms into support. This is facilitated by the bulls. They had previously declined to purchase at a cheaper rate, but now, they’re trying to make up for the missed opportunity and buy during the breach and the return of prices to the previous level.

If prices fall below the support level, it can turn into resistance. Investors start selling more actively when the price is near the former support level.

How to Draw Resistance and Support Levels

Many new traders ask how to correctly draw resistance and support levels.

A support level can be drawn across 2 or more lows. Conversely, resistance levels should be constructed across highs.

The importance of resistance and support levels can be determined by such parameters:

• Time scale;
• Number of touches;
• Duration;
• Slope angle.

The importance of a level increases with a larger time scale. That is, levels on a weekly chart will be much more significant than those on a daily chart.

The more touches there are, the more reliable the level will be. It could be said that a third touch makes it more significant, and a fourth and fifth touch reveals the substantial potential of the dominant group in the market.

The longer the duration, the more reliable the level will be as a reversal signal during a breach and more reliable as a guide accompanying the current trend.

Drawing resistance and support levels may seem fairly straightforward. However, working with them is much more complex. It all depends on your practice. The more you work, the faster and more accurately you will understand this information.