Support and Resistance Indicators are very important technical concepts used by traders to analyze stock charts. In this article, we will define them and help you understand how they are used.
What Is the Support and Resistance Indicator?
You can define the concept of Support as the price level, area, or zone where the traders may expect the demand levels from the buyers to increase. This gives support to the price level and helps prevent prices from falling downward any further. On the other hand, Resistance is the price level, area, or zone in which a trader may expect the supply to increase and hence prevent the price level from further moving upwards.
One thing that is very important to understand here is that we are not talking about a single price level, and rather about some zones or areas where the price may increase or decrease. Even when there is a situation in which the prices go a single tick above an identified resistance or support level, it does not indicate anything serious.
For those who are new to this, it is also important to explain why certain levels are considered as magic numbers where traders can predict or expect a particular kind of outcome from the stocks. Let us delve into some details of this to make things clearer.
To put it very simply, you have to understand that at the resistance level, traders consider a stock to be expensive, while at the support level, they consider it to be cheap. These predictions of traders are based on their past experiences or data. On this basis, traders make their decision about whether they should stay in the market or not.
The data as well as the memory of investors and traders helps them recall how the stocks behaved at the particular support or resistance level. If they believe that that they do not have any more chances of increasing the prices, they consider it to be a good time to sell their stocks. Similarly, when they expect that the prices will not fall any further, they consider it to be an ideal time to buy as many stocks as they can. In other words, the decision of the trader about whether he should buy or sell is influenced by how he expects the price levels to react at particular support and resistance levels.
As mentioned earlier as well, Support and resistance are very basic concepts that any trader familiar with Technical Analysis understands. A wise trader is believed to be the one who understands them the best, keeps an eye on them, and makes his decisions on their basis. We can conclude this section of defining these concepts by saying that these two are basically those levels where traders expect the price to turn. These levels may help make predictions but do not guarantee that those predictions will always be correct.
How Can a Trader Find Support and Resistance
Different traders may have different tips and methods. However, there two basic ways that can help a trader in identifying support and resistance. The first method is to look at the horizontally aligned tops and bottoms and the second method is to identify what the trend is by analyzing multiple tops or bottoms. In the sections that follow, we will briefly look at each of these methods.
Analyzing the Horizontally Aligned Tops and Bottoms
In this method, a trader looks at the stocks from tops and bottoms. For instance, at the bottom, there is a local price formation that shows that the earlier prices, as well as the later prices, are higher than the lowest price in the particular range. A trader may identify that there are multiple tops or bottoms, or sometimes both, aligning on the chart horizontally. In other words, if they are at the same price levels, then the trader can simply draw a horizontal line to determine whether it a support indicator or a resistance indicator.
Trendline Formations by Connecting Multiple Tops or Bottoms
The other method that we mentioned earlier, as the name suggests, works by trying to identify a trend in the stocks. When a trader notices that the stocks are always forming higher bottoms, or the other way around, they can connect all the dots to identify a pattern or what the traders call a trendline. This trendline is what then determines the choices that a trader makes.
Support and Resistance Indicator
Traders may draw these lines and identify support or resistance manually. However, there are now many apps and websites that allow them to find the support and resistance lines easily with the help of automated lines drawn on their stock charts.
There are different types of support and resistance indicators. For instance, an overlay indicator is one of the best indicators that makes use of both methods that we have explained above. It draws both the trendlines and the horizontal lines to get the most accurate results.
Some indicators that you will find can also help traders by displaying multiple zones of support and resistance with the help of different indicators that are used at different times.
Some Important Things to Know
There are a few things that the traders have to keep in mind when looking at a support and resistance indicator. These things will influence how significant the indicator is. For instance, the longer the time frame is, the more accurate the results are and the more reliable the indicator is. Similarly, the greater frequency of checking the support or resistance line, the more significant the results. For instance, a trend line that is made using 6 bottoms is more significant and reliable than a trend line that is built by only considering two bottoms.
Another thing that affects the significance of these indicators is how recent the line is. Considering very old bottoms or tops is never a good idea as things keep changing in the stock market and shareholders usually do not behave the same way.
In this article, we have explained the concept of a support and resistance indicator, how these indicators are used, and how they work. We have also explained some of the factors that influence the significance of these indicators. A good support and resistance indicator is one that takes all these factors into consideration when determining the support and resistance levels.