While listening to a business television channel or reading a newspaper, you would have come across the terms support and resistance levels. These terms are used in connection with the price trend of a particular share. Though the technical details of these may be a bit difficult to understand for a layman investor, it’s good to know what they represent as the trading community relies heavily on them.
Support price level of a particular stock is that lower level below which the price of the share has not gone in the near past. To arrive at this, the price of the share over a period of time is observed and a price trend line is drawn. Then a straight line joining the lowest tips, representing the lowest prices that the share has hit, is drawn on a price chart. This straight line denotes the support price level for that share.
For example, if company X’s share price has hit the level of Rs 100 a number of times in the last few months but has bounced back immediately and has not gone down below Rs 100 level, Rs 100 becomes the imaginary support level for the stock price. Essentially, this means that there are buyers who are ready to buy the share at Rs 100 level and whenever the price comes close to this point, buyers see value into the counter which again pulls up the price.
In contrast to support level, resistance level is the upper price level that a share price struggles to breach. In this case, the highest tips of a price trend line are joined by a straight line on the price chart. In the above example, if the price of X has hit the upper level of Rs 200 a number of times in the past few months and has retreated soon after, Rs 200 is said to be the resistance level. This means that buyers are not ready to pay more than Rs 200 a share and there are sellers in the market at this price level as they see it as being fairly priced.
Technical analysts use various other tools such as daily moving averages for a stock price to arrive at support and resistance levels. They use different time periods for these moving averages to find the one that is most relevant to their analysis.
How do you interpret them?
These levels indicate buying or selling opportunities. Taking the example above, suppose you want to buy stocks of company X. If the prices are around Rs 100, you would know that it’s unlikely that they would go lower and would indicate it’s a good time to enter. On the other hand, if you are holding the stock and want to exit with maximum returns, the resistance should be a reasonable indicator.
Have these levels been breached?
Yes, these are not concrete indicators. Levels can be breached any time depending on the overall sentiment of the market or some change pertaining to that particular stock. Fundamental changes such as an expansion plan or the company getting involved in a court case can have a positive or negative impact on the stock price and breach the resistance or support levels, respectively. So don’t base your decision on these alone, rather use them as indicators of price movement.