The most basic tendency of traders is to buy stocks at a price level that they consider is very low and to sell a stock at a price that they consider is relatively high.
When the majority of traders believe that price is relatively low, buying pressure overtakes the selling pressure and the price generally goes up. Likewise, when a majority of traders believe that a stock is relatively high, selling pressure overtakes buying pressure and the price generally goes down.
Traders have a basic tendency to buy stocks at a relatively low price and sell at a price that is considered to be relatively high. Low and high levels are determined based on what traders consider it.
When the price of a stock touches support, it’s considered as a good time to buy. Likewise, when a stock hits resistance, it might be a good time to sell.
Instead of taking support and resistance as a point, many traders consider it as a zone or area where stock prices are bound to show some sort of resistance before moving higher or lower, as the case may be.
In our last article, we have discussed what are support and resistance levels and how support becomes resistance and vice versa. Let us discuss what dynamic support and resistance levels are and how it differs from horizontal support and resistance levels.
Dynamic support and resistance levels
Trend lines, moving averages, upper and lower channel lines are known as dynamic support and resistance lines in price action.
The significance of a trendline relates to how many times it has been touched or approached before moving up or down.
When prices move back to an up-trend line or a moving average and bounces, it is reinforced as a dynamic level of support.
Likewise, when prices move down to a downtrend line or a moving average and bounces, it is considered as a dynamic level of resistance.
Many traders, considering these levels and dynamic support and resistance lines, prefer to buy as the price falls to an up trend line or moving average and sell when it rises to a down trendline or moving average. They prefer to put their stop loss beyond the moving average or trendline in case the trade goes against them due to violation of support and resistance levels.
Gaps are emotional points as they are formed when buyers or sellers respond emotionally to news or events that a blank space or gap is left on the chart.
Technical analysis deals with probabilities.
Support and resistance are points where prices may halt temporarily. However, they are not signals to buy or sell. At these points traders anticipate a reversal. Here are the most important potential support and resistance zones;
- Previous highs and lows,
- Trendlines,
- Moving averages,
- Parallel channels,
- Emotional points on charts,
- Gaps, and
- Fibonacci proportions.
What is horizontal Support and Resistance Lines
Horizontal support and resistance lines are drawn by connecting the approximate highs and lows of price bars on a chart. While drawing these lines, you should make sure that it’s drawn as close to the majority of highs/lows as possible.
Support often becomes resistance and resistance often becomes support.
All time highs and lows are amongst the most important support and resistance levels. Traders remember these levels much better than any other price levels.
After plotting horizontal support and resistance levels, traders closely watch for price reaction at these levels. In an up-trend or downtrend, traders closely watch for bounces or breaks in the direction of the ongoing trend. In a sideways trading range market, bounces between support and resistance offer trading opportunities.
The moving average is often used as a dynamic support and resistance indicator, much in a similar fashion as a trend line.
For example, in any trading time frame, 20-period simple/exponential moving average is considered to describe a strong trend. It also acts as a dynamic support line for an uptrend or a dynamic resistance line for a downtrend.
Why to recognize these support and resistance levels
Human memory coupled with emotions and fundamental factors creates support and resistance.
Support and resistance are areas or zones, not exact prices. It works like a ceiling. These are the actual outcome or the result of the interaction between fear and greed and supply and demand.
Resistance is a ceiling zone where the stock will meet with sellers, at least temporarily. To break this level, the stock has to gather enough buyers to accelerate through it.
The more times a stock tests resistance, and the more extended time it does so, the more bullish it is when it breaks that level.
You need to study various charts in different time frames until you recognize support and resistance levels automatically.
Many technical analysts suggest drawing lines across the edge of the congestion zone where the bulk of the candles stopped to mark as support and resistance levels. Congestion zones suggest that within this zone, mass market participants have changed their minds. Excrement points of the congestion zone reflect only panic among weak traders.
Minor support and resistance levels cause trends to pause, while major support and resistance causes them to reverse.
Traders assign more weightage to the support and resistance zone identified in a longer time-frame rather than a smaller time frame.
Technical analysts suggest tightening your protective stop when price approaches the support and resistance level. A stop loss order will protect you from getting badly hurt by a reversal.
