Understanding Support and Resistance: More Than Just Fictitious Concepts
Support and resistance have long been debated concepts in the world of financial markets. These terms often appear in somewhat mystical terms, suggesting that tea leaves and crystal balls can predict price movements in the world's largest Ponzi scheme. However, these concepts are fundamentally descriptive tools used to understand potential price movements in stocks and other financial instruments, though they also fall short as precise or infallible predictors.
Support and Resistance: Descriptive Tools with Limited Predictive Power
Support refers to a price level or zone that acts as a barrier when the price is trying to fall. It is a place where the price bounces back. On the other hand, resistance is a level or area that acts as a barrier when the price is trying to rise. The idea is that these levels or areas are enclaves where price movements are likely to reverse. However, fundamentally, support and resistance are just a guess, more descriptive than predictive.
Practical Applications of Support and Resistance
The concept of support and resistance is a useful tool for traders to identify potential turning points in the market. Here are a few practical applications of these concepts:
Breaking Resistance: An Indication of Strong Inflow
When a stock is moving upward and encounters resistance but manages to break this resistance with significant trading volume, high chances are that the stock will continue its upward movement. This is because the stock was previously maintaining a resistance level that it could not break, and now the successful breaking of this resistance suggests that a new, and possibly larger, group of buyers has entered the market, driving up prices.
Buying on Support for Profitability
When a stock falls and bounces off the support level, it is generally a good time to buy the stock. Empirical evidence suggests that buying on support works well and can provide favorable risk-reward ratios. However, if the stock fails to sustain at this level, it is then a sign that the stock may no longer have the necessary strength and has turned weak. In such a scenario, traders should either stay away or, for experienced individuals, consider short-selling.
Identifying Support and Resistance Levels
Traders can use various moving averages to identify these support and resistance levels. Two particularly useful tools are the 20 DEMA (Double Exponential Moving Average) and 50 DEMA (Primary Exponential Moving Average) for short-term support and resistance, and the 200 DEMA (Long-Term Exponential Moving Average) for long-term support and resistance.
Key Findings
When a stock breaks through resistance, that resistance level becomes a new support level. Conversely, when a stock breaks through support, that support level becomes a new resistance level. When a support or resistance level is tested multiple times (3-4 times), it weakens, and the chances of the break increase.It is also important to note that a strong stock should not break through the 50-day DEMA in an uptrend. This is a key trading rule to keep in mind.
Conclusion
Understanding support and resistance can be a valuable tool for traders, but it’s important to remember that these concepts are not infallible. They are descriptive tools that provide insights into potential market movements. As always, thorough research and careful consideration are essential before making any trades.
References
For more in-depth analysis, refer to the following blogs:
- [Blog 1]() - [Blog 2]()