Many of us hear the terms support and resistance quite a lot, but to many of us their meaning is quite unclear.
The concept of support and resistance is extremely important in the trading decision making process.
The demand and supply relationship can explain both terms. Support is an area on the chart where buying interest (demand) is stronger than selling pressure (supply), the effect is a halt in a downtrend or a reversal in the other direction.
Resistance is an area on the chart where selling pressure (supply) is stronger than buying pressure (demand), this will cause advancing prices to halt and reverse direction.
By looking at any price chart, you will notice that it is made of a series of peaks and troughs, those peak and trough actually have names, the troughs are support levels and the peaks are resistance areas.
The concept of support and resistance is further explained by using the analogy of a battle between bulls (the buyers) and bears (sellers). The bulls push prices higher and the bears push prices lower.
The winner of the battle can be known from the direction of prices.
Whenever prices start to fall obviously the bears are winning, however there comes a point where the bulls take over and prices reverse, this is a support level, buyers are supporting the price.
Prices will continue to move higher, until a point is reached where sellers outnumber buyers and prevent prices from rising, this is a resistance level.
Some traders make their buying and selling decisions by using the support and resistance concept, they sell at resistance levels and buy at support levels.
Support and resistance areas gain their importance from three things:
1. Amount of volume that changed hands in an area. The more volume that changed hands, the more significant an area becomes.
2. The number of times a support or resistance level has been tested, meaning the number of times prices bounced of the area and did not penetrate it.
3. How recently a support or resistance area has been tested, an area tested three months ago is more significant than an area tested a year ago.
Important support and resistance areas for the Tadawul All-Share Index (TASI) as of the closing of June 28, 2006 are 12,800 for support and 13,248 for resistance.
A support or resistance penetration is triggered by changes in investor’s expectations; this implies fundamental changes that are above or below investor expectations (e.g., changes in management, expected earnings, competition, etc.) or by investors buying as they see prices rising and vise versa.
The cause for the penetration may not be know, however it appears on the price chart and that is all that matters. Support and resistance are truly powerful technical tools.
A solid understanding of the concept can make the difference in buying and selling decisions.
