Support and resistance are two concepts used in the field of technical analysis which attempt to determine the price level at which to buy or sell a security. Support refers to a price level that tends to act as a floor by preventing the price of a security from falling any further. Resistance refers to a price level that tends to act as a ceiling by preventing the price of a security from increasing any further. Support and resistance levels can be identified by relatively simply chart analysis. These levels are usually identified by periods of consolidation whereby the price of a security moves within a confined range. This period of consolidation informs us that the forces of supply and demand in the market are deadlocked. When prices move out of the trading range it signals that the deadlock may be coming to an end. If prices moves above the level of resistance, then the demand for that security is increasing. If prices move below the level of support, then the supply is increasing.
Support and resistance can be useful to both range traders and trend traders. Range traders will buy a security when it reaches the level of support and sell the security when it reaches the level of resistance – in doing so they make a series of small profits during these periods of consolidation. Trend traders will use these levels to determine the price level at which a breakout is likely to occur – when the breakout occurs the trend trader will then realise a large profit from this movement.
While this method of technical analysis can be very useful in determining the price level to buy or sell a security it can however be open to subjective bias and one’s own interpretation. At first the idea behind finding these levels seems relatively straightforward, but support and resistance can come in various forms and these levels are not always easy to identify. Therefore, having a complete trading strategy is paramount to the success of any trader who practices this method of security analysis.