Technical Analysis

How to identify supports and resistances

BL Research Bureau | Updated on November 15, 2017 Published on April 07, 2012

Two of the most frequently used words in the technical lingo are supports and resistances. These are the mostly cited to point out the levels where a trade can be entered into or exited or the points at which an investor can purchase a stock or book profits.

What are supports and resistances? Supports are nothing but troughs (reaction lows) from where a downward movement can reverse. The sellers turn tentative at these levels and the buyers have the chance to wrest the advantage here. The reverse is true with resistance, which are previous peaks. The buyers get edgy at these levels and sellers gain more power.

Chart of Wipro depicts the support and resistance levels. Wipro halted its declines during August and November 2010 at Rs 400, making this level a significant support. This level also provided support during December 2011 and January 2012 while the stock was trending higher.

Key resistances are marked in chart at Rs 450 and Rs 490. Note how the stock price reverses down from exactly the same level at Rs 490 in December 2010 and April 2011 at which the previous peak was formed in October 2010. The stock is currently testing the resistance at Rs 450 from which it had reversed in February this year. This is not always the case. A 5 per cent leeway can be allowed for the second or third peak/trough's formation.

How do these support and resistance levels work? Well, these are important points of reversal in the past. Every time the price nears these levels, the memories of investors go clickety-clack. They say to themselves, “hey, the price turned from here once so it can very well do so again”. That is how these levels prove to be so effective. The human element!

The supports and resistances discussed above pertain to the highest price on a day when a major peak is formed or the lowest price on a day when a significant trough is formed. Other ways in which supports and resistances are derived are with the aid of trend lines, trend channels, Fibonacci retracement levels, moving average lines pattern supports and so on.

If a stock has reversed from a certain price more than once in the past such supports and resistances gain greater credibility. Once a support level has been effectively breached, it turns in to a resistance level for future upward movements. Similarly resistance levels, once crossed emphatically turn in to supports for future downward movements.

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