Support and Resistance
When the price pattern on the chart is making its way up and pulls back, the highest point reached before it pulls back down is called resistance. As the market climbs back up again, the lowest point reached is now called support. So resistance and support are constantly formed as the market fluctuates.
Technical analysts use support and resistance zones to identify points on a chart where a pause, or the reversal of a prevailing trend is likely to occur. In other words, they identify areas of supply and demand. Supply is an area on a chart where sellers are likely going to overwhelm buyers causing the stock to go down; on the chart it is called resistance. Stocks find support (demand) because those traders that missed the move up now have a second chance to get in so they buy.
Once an area of support or resistance has been identified, it provides valuable potential trade entry or exit points. This is because as price reaches a point of support or resistance, it will do one of two things: bounce back away from the support or resistance level, or violate the price level and continue in its direction.
You must bear in mind that support and resistance levels are not precise figures. You will sometimes notice the support and resistance levels seem to be broken, but soon after you find out that the market was testing in with the candlestick chart. These tests of supports and resistance are usually represented by candlestick shadows.
Price charts allow traders and investors to visually identify areas of support and resistance, and give clues regarding the significance of these price levels.
Looking at the charts you can plot the resistance lines around areas where you can see the prices’ peaks and valleys.
Anticipating Support and Resistance Levels
While it is easy to identify areas of support and resistance once they are well established, it is helpful to be able to predict where these zones may occur. Market participants can use a variety of methods to recognize where important support and resistance zones are likely to occur.
Some of these key methods are trendlines, and pivot points.
A technical analysis indicator used to determine the overall trend of the market over different time frames. The pivot point itself is simply the average of the high, low and closing prices from the previous trading day. On the subsequent day, trading above the pivot point is thought to indicate ongoing bullish sentiment, while trading below the pivot point indicates bearish sentiment.
A pivot point analysis is often used in conjunction with calculating support and resistance levels, similar to a trend line analysis. In a pivot point analysis, the first support and resistance levels are calculated by using the width of the trading range between the pivot point and either the high or low prices of the previous day. The second support and resistance levels are calculated using the full width between the high and low prices of the previous day.
So basically a pivot point and its support/ resistance levels are areas at which the direction a price can possibly move to. These prices are taken from a stocks daily chart, but pivot points are calculated using hourly information from charts.
Supports and resistance level are calculated off of this pivot point using the following formula:
Central Pivot Point (P) = (High + Low+ Close)/3
Support and resistance levels are then calculated off of this pivot point using the following formula:
First Resistance (R1) = (2*P) – Low
First Support (S1) = (2* P) – High
The second level of support and resistance is calculated as follows:
Second Resistance (R2) = P + (R1-S1)
Second Support (S2) = P- (R1-S1)
Pivot points are seen as the primary support or resistance level and also are popular tool to use in the forex trading market as many currency pairs tend to fluctuate between these levels.
Pivot point allows traders to see important levels that need to be broken for a move to qualify as a break out. These technical points are useful as the markets opens.