Support & Resistance Levels

This form of technical analysis looks at where the forces of supply and demand meet, helping traders determine participant psychology and hence, where prices could go next.

A support level is a price at which - historically - the stock has always rebounded upward. As shown in the above image, whenever the price of the asset hit the support level in the past, we saw a rebound.

The rationale behind this is manifold: on the one hand, it is presumed that the security has reached a level of value that invites investors to buy, on the other hand technical analysts notice the rebound and empirically expect it to happen again - a form of self fulfilling prophecy. Reaching that level is often seen as a good entry point and if the stock breaks through the resistance level then traders will assume it has further to fall.

Resistance levels work in the mirror way: they provide barriers to further appreciation, and are observed closely - if a security can break beyond a resistance level then it is likely to appreciate further in the assessment of some traders.

The same applies to yields:

Support refers to the yield level that an asset does not fall below for a period of time. An asset's support level is created by sellers exiting the market whenever the yield drops to this level, no longer finding it attractive enough to hold it. Reaching that level is often seen as a good exit point.

Resistance, on the other hand, is the price at which the yield of an asset meets pressure on its way up by the emergence of a growing number of buyers who wish to buy at that price (thus lowering the yield). Similar to asset prices, resistance levels can be short-lived if new information comes to light that changes the overall market’s attitude toward the asset, or they can be long-lasting.

What happens when a support or resistance level is broken?

Let’s say the price of an asset falls below a support level (since the company missed earnings), that level will become the new resistance level. On the other hand, if the price of an asset rises above the resistance level, that level becomes the new support level. This is because the supply and demand for the asset has changed, causing the crossed levels to reverse their role.

Technical analysis is a great tool for all investors: some choose to use fundamental and technical analysis together, using fundamental analysis to choose what asset to buy and technical analysis to decide when to buy.