Investment: Technical Analysis basics 3

Introduction to Support and Resistance
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Support and resistance are important parts of technical analysis, where supply and demand meet. Prices are driven by excessive supply and demand. Supply is synonymous with “bears” and selling. Demand is synonymous with “bulls” and buying. As demand increases, prices advance and as supply increases, prices decline. When supply and demand are equal, prices move sideways.

Support is the price level at which demand is strong enough to prevent the price from declining further. As the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches support, demand will overcome supply and prevent the price from falling below support.

Support does not always hold and a break below support signals that the bears have won out over the bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive to buy. Support breaks and new lows signal that sellers have reduced their expectations and are willing to sell at even lower prices. Buyers cannot be coerced into buying until prices decline below support or below the previous low. Once support is broken, another support level will have to be established at a lower level.

Support levels are usually below the current price, but it is not uncommon for a security to trade at or near support. In addition, price movements can be volatile and dip below support briefly. For this reason, some traders and investors establish support zones.

Resistance is the price level at which selling is strong enough to prevent the price from rising further. As the price advances towards resistance, sellers want to sell and buyers become disinclined to buy. By the time the price reaches resistance, supply will overcome demand and prevent the price from rising above resistance.

Resistance does not always hold and a break above resistance signals that the bulls have won out over the bears. A break above resistance shows a new willingness to buy and/or a lack of incentive to sell. Resistance breaks and new highs indicate buyers have increased their expectations and are willing to buy at even higher prices. In addition, sellers cannot be forced into selling until prices rise above resistance or above the previous high. Once resistance is broken, another resistance level will have to be established at a higher level.

Resistance levels are usually above the current price, but it is not uncommon for a security to trade at or near resistance. Also, price movements can be volatile and rise above resistance briefly; therefore, some traders establish resistance zones.

It is possible that support can turn into resistance and visa versa. Once the price breaks below a support level, the broken support can turn into resistance. The break of support signals that supply has overcome the demand. Therefore, if the price returns to this level, there is likely to be an increase in supply, and hence resistance. The other situation is resistance turning into support. As the price advances above resistance, the breakout above resistance proves that the demand has overwhelmed the forces of supply. If the price returns to this level, there is an increase in demand and support will be found.