Understand what are Supports and Resistances: One of the most elementary concepts while trading in stocks that every trader should know is, “Supports and Resistances”. If you’re already involved in the market, you might have heard or read terms like “Nifty50 has got a big resistance at 10,800 points” or “Stock XYZ has a support line at Rs 105”. So, what exactly do the traders mean by these terms in their analysis? We are going to discuss that through this article.
In this article, we are going to discuss what are supports and resistance, their characteristics, and how exactly to use them. By the end of this article, you will have a good idea about these concepts and use them in your trading. Let’s get started.
What are Supports and Resistances?
The Synonym for the word support is “Reinforce”. Basically, support can be said to be a point of reinforcement. In other words, supports are those points which acts as a barrier for the prices, when they start to some down. They can also be said as points, where the downtrend is expected to be paused. And we should see a new surge in buying and demand. In short, supports are those points, where buyers are more forceful than sellers.
On the other hand, Resistances are said to be the point where the supply increases or the longs start getting out of their positions from the market. Therefore, if we were to carefully analyze, supports and resistances can be said as the point of friction or tussle between buyers and sellers. And Resistances, are those points where sellers have higher say than buyers.
Now, once the level of Supports and Resistances (S&R) are identified, they become the point of entry or exit for the trade. The prices either bounce back or correct back, from S&R level or breach these levels and go to next S&R.
Characteristics of Supports
Here are the key characteristics of Supports while looking into the charts:
- Supports are those points or levels, below which the market finds difficult to fall. They can also be said as point of infliction between buyers and sellers.
- Supports are also the point of Maximum demand from buyers, and even the sellers exit their selling positions from the market.
- The buyers have a higher say in deciding the levels of support in the market. These levels can also be said to be mainstay for buyers.
- Supports, if breached sees a quick sell off in the market, and then the next level of support becomes a point of contention.
- If the levels of supports holds in the market, then fresh longs can be initiated and generally these trades have good risk to reward ratios.
— Understanding Supports with an Example
The figure below shows the daily chart of HDFC Bank. Through this chart, we get a clear illustration on the concept of supports and the impact on the market, if the supports are respected or breached.
Figure 1: Daily HDFC Bank chart (Source- Kite Zerodha)
Now, if we carefully look, the market finds a very strong support in the range between Rs. 1030 and 1075. The sellers continuously try to breach this levels, but to no avail. And after forming a base at these levels, the market starts going up.
And, we see continuous buying momentum in the share price of HDFC Bank. A Trend line support is formed in the market by joining three points from where the market is bouncing. In this rally, the share price of HDFC bank moved up from 1030 levels to almost 1250 levels (a near 20 % gain).
And the moment, the price of the shares of HDFC bank breaks the Trend line support, we see an increased selling pressure and the longs unwind from the market. Following which, the share price of reaches the initial support levels near dotted lines (Figure 1). And after finding support at these levels, the market starts to rally back and we see continuous buying in the market and it nearly makes of move of 25% form there.
So, if we were to just use simple supports patters while trading the above chart, we would have got a minimum of three trades with a minimum of 15% returns
Characteristics of Resistances
Here are the key characteristics of Resistances while looking into the charts:
- Resistances are the levels which are defended by sellers. And the market finds it difficult to go beyond that level. It is a tussle point between buyers and sellers.
- Maximum selling pressure comes from sellers at this point and even the buyers start to exit their long positions at these levels
- If the levels of Resistances are breached in the market, we could see a massive short covering in the market, up to next resistance levels.
- Resistances can also be called as points where fresh short positions can be initiated in the market, with good risk to reward ratio.
— Understanding Resistances with an Example
The figure above is a weekly chart of Airtel Limited. Through this chart, we get a clear illustration on the concept of Resistances, and the impact on the market if the resistances are breached.
Figure 2: Weekly Airtel chart (Source- Kite Zerodha)
The Share price of Airtel Limited had made a new high in the year 2007 and after that, the market had corrected nearly 50% from its highs. And then again, the market made a move up and went up till near 500 levels and started correcting again. And by joining these two points, of the initial high and the recent high, we could form a trend line.
So, now this trend line forms an important resistance in the market. As and when the market made a move up, this trend line acted as an important barrier and the market started to correct back. And the market was able to breach this resistance in the Mid-2014 and the share price had massive short covering. And the market made a move till the initial swing highs of 570 levels. Therefore, this is the power of Resistances, when an important level is breached.
Now, let us understand the concept of swing trades. If we look at Figure 2, we have marked swing trade. Swing trades are those trades which we hold for a longer duration of time, usually for the completion of one full cycle. These are the trades which have a longer holding period. And we generally don’t have a profit target in place, we just keep trailing the Stop losses and ride the wave.
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In this article, we tried to simplify the concept of Supports and Resistances while looking into the charts. Let’s quickly conclude what we discussed today.
Supports and Resistances are important points of significance on charts as we get good entry or exit points for our trades. On one hand, Supports are defended by bulls/buyers and on other hand, Resistances are defended by bears/sellers. These levels of Supports and Resistances can be used to identify targets for the trade and also for keeping Stop losses for existing trades. As a thumb rule, for a longer trade, look for the immediate resistance level as target. On contrary, for a short trade, look for the immediate support level as target.
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!