Support and resistance levels are very critical to not only trading in the market but also for investments. So let’s calculate the support and resistance levels.
Support and resistance levels are the most crucial aspect to understand when trading or investing in the market. You read it right, and it is not a mistake. Even when investing.
The complete support and resistance topic is beyond an article, but I will try and make it compact and explain the support and resistance level as well as cover some of the common myths about it. The topic is covered in detail in the book Right Stock at Right Price for Right Time.
So instead of making it a post of book promotion, let us now begin and understand support and resistance levels.
What is Support and Resistance in Trading?
To put it simply, the support is the demand zone, and resistance is the supply zone.
This one line should explain everything you need to be knowing about support and resistance levels when trading in the market.
So now, if we apply the basic concept of demand and supply, it is easy to predict. From a demand zone, the stock price should increase. Similarly, from a supply zone, the stock price should decrease.
So a support zone is the price point where stock doesn’t fall beyond a particular price level.
Similarly, the resistance level is the price point where stock finds tough to go past it.
Support and resistance level is a fairly simple concept. The problem is, traders make it complicated when calculating the support and resistance level.
The 200DMA acts like magic, and the reason being, at 200DMA, there is a demand in the correction of an uptrend and supply in case of correction in the downtrend.
Calculating support and resistance isn’t as complicated as it may sound, either. So let us now do the calculations.
How to Calculate Support and Resistance?
There are many ways to calculate support and resistance levels. 200DMA is one of them.
My view is, the most reliable of all calculations is the price action strategy. Within the price action strategy, there are 4 to 5 patterns that one can use to calculate support and resistance levels.
I will share one of them here, and it is using the support and resistance trend-lines.
I will use the same daily chart of Marico I used in my previous article for understanding the target levels.
Blue lines indicate the stock is not willing to break these levels.
If one is specific about the shadow of candlesticks, there is a price range that stock is not willing to break. It is ₹350 to ₹360. So, it is the support zone for the stock.
Similarly, the green line is the resistance level for the stock. Stock is trying to get past it but is not able to do it.
It will need a piece of good news in the form of earnings or something else to get past the significant resistance level. Similarly, on the downside, the stock needs an awful result to break the significant support level.
I know the support and resistance calculation above seems too simplistic, but it is the reality. The calculation of support and resistance level is straightforward if one knows how to do it.
There are other patterns to find support and resistance levels like Cup formation, Flag formation, Round bottom pattern, Pivot point calculations, etc. All are very simple and easy to understand.
What do Support and Resistance Tell You?
There is very little that changes on a minute to minute basis in the fundamentals of the company.
However, the sentiments of the participants, aka trader and investor for stock at a particular price point, keep changing.
The bad news can have a ripple effect, and the stock prices fall like a pack of cards. The traders will always be with the trend. At some point, the investors find value at a price and start accumulating, forming a support zone.
Similarly, good news can form the same ripple effect on the upside. Traders jump in to trade with the trend. At some point, the investors find the price to be way above the value. Traders and investors booking profit form a resistance zone.
To break the support, one needs investors to stop accumulating as well as the traders to stop covering the short positions and vice versa for resistance.
Good earnings mean resistance is taken out because investors aren’t willing to sell at elevated prices anymore, and traders are in no mood to cover their long positions. Similarly, bad news makes the support to breach.
So the earlier support and resistance tells us how the news flows may have been without even consulting any newsroom.
Similarly, if one expects the future support or resistance levels to be taken out, the same type and kind of news flows may be needed.
What are the causes of Resistance?
The only cause of a resistance level is supply. There can be various reasons for the supply, and I will share some of them.
So if a big brokerage house has a target price for a stock at a key level like, for example, in the above chart of Marico, we see ₹400 as a key resistance level. It can mean some large investors are willing to offload the stock at that level.
With resistance level in view for the traders, most positions trader take will have target under ₹400.
What are the causes of Support?
Similar to resistance, the only cause of the formation of support is demand. There is no other reason for the formation of support levels or support zone.
The reason for a demand in particular stock can vary. One of the reasons for the demand is the price, which is value buy for the investors.
Do Support and Resistance Work?
Do supply and demand work? If your answer is yes, the answer to whether support and resistance work is also yes.
The reason we have this question is that the flaw in the calculation of support and resistance levels.
If you are miscalculating the support and resistance level, you may get the feeling, the support and resistance levels don’t work in the market.
So if support and resistance level don’t work for you, it is time to reconsider the calculation you are doing for it instead of doubting if support and resistance level work or not.
What happens when a stock breaks Support Zone?
When a critical support level breaks, the stock will have a free fall for sure.
Here is the weekly chart of Amara Raja Batteries, where the key support level shown with a blue line.
The support is around ₹700 on a weekly chart, which means it is a significant support level. As it breaks, the stock free fall to ₹575.
And then Support Becomes Resistance.
The reason for the fall is supply. The supply is vast because the bad news makes the investors go in the wait and watch mode. Long traders hit the stop loss and square off the position giving additional supply. The short sellers jump in to cash in because the critical support zone has been violated.
All in all, when support breaks, the free fall is inevitable.
What happens when a Stock breaks a Key Resistance Level?
When the critical resistance level is taken out, it can mean the stock can have a significant uptrend.
Here is the daily chart of Zydus Wellness, where key resistance level shown with a green line.
When the stock decisively moves above ₹1400, there is no stopping for it before ₹1850.
In nine months, the stock is trading between ₹1200 to ₹1400, but when ₹1400 is taken out, it reaches ₹1800+ in over a month.
The power of resistance when taken out.
There are chart patterns to trade with support and resistance strategy. They help in calculating the support levels, which acts as a stop loss and resistance levels to guide us with targets.
I hope the article helps all Indian retail investors to understand the support and resistance and apply it to trading as well as investing in the market.
I am sure you will have more questions, and I will be more than happy to answer them all for you. So if you have any further questions, feel free to ask them in the comments below.