Resistance and support levels are basic concepts that are essential in trading. They indicate the different layers of ‘walls’ that a stock has. The walls that prevent the price to go higher are called the resistance levels. The walls that prevent the price to go lower are called the support levels. Resistance and support levels can be broken and when that happens, the broken wall switches roles. A broken resistance becomes the new support. A broken support becomes the new resistance.
There are short term resistance/support levels and long term resistance/support that can be found using a bigger time interval. This can be for example a stock that reached 3 times close to a 100$ but never broke that resistance, retraces back and trades for a month in between a new support of 50$ and resistance of 70$. The short term support and resistance levels are 50$ and 70$, but there is a long term resistance of 100$ that remains effective the moment stock prices reach near that level later on.
A resistance level is a price range where the stock price drops to the downside from that level. For a price range to be considered a resistance, it needs to retrace from that top level at least twice. The more it retraces from that level, the stronger the resistance.
The reason that there is retracement at resistance levels is because there are less buyers and more sellers around those price range. It is a price range where there will be profit taking and less buyer because it is considered too high to buy in a stock when compared to previous price range. Also, at resistance level some traders might also short the stock at resistance level. Shorting the stock in simple term is making money with the downtrend of a stock. If you short the stock and it goes down, you make money. If you short the stock and it goes higher, you lose money.
A support level is a price range where the stock price rebounds to the upside from that level. For a price range to be considered a support, it needs to rebound from that bottom level at least twice. The more it rebounds from that level, the stronger the support.
The reason that there is a bounce at support levels is because there are more buyers than sellers around those price ranges. It is a price range where there will be ‘buying the dip’ and less sellers. Also, short sellers will also take profits at support level.
Resistance & Support Example analysis
On the left hand side of this example, we notice that the price action was in between a resistance level and a support level. Then the resistance breaks and turns into a new support level. The price also reaches a new high that was stopped multiple time around a new level which we identify as the new resistance level.
In the case that the new support breaks, it will come back, and the old resistance and old support level will still be effective. Therefore, it can be useful to always keep identified resistance/support level as they can be useful further down the line.