What Is Support and Resistance?
Support and resistance are price levels that traders look at when they’re applying technical analysis to their investing.
“Support” is where the price of an asset tends to stop falling and “resistance” is where the price tends to stop climbing.
While support and resistance levels are rarely the sole indicators used to determine when to buy or sell, they can provide helpful clues to estimating when a price trend may pause or reverse.
Here’s a closer look at technical analysis, support and resistance levels, as well as how investors can use them.
Technical Analysis 101
Technical analysis is a type of trading method that uses price patterns to forecast future movement. It differs from fundamental analysis, which is based on using a company’s financials, like its earnings and revenue. Professional technical analysts are called Chartered Market Technicians or CMTs.
A general rule of thumb in investing is that past performance never guarantees future results. However, technical analysts believe that because of market psychology and sentiments like fear and greed, history tends to repeat itself. So for instance, if an asset falls a certain amount, buyers tend to swoop in.
In addition to price levels and their historical patterns, technical analysts may look at volume, oscillators – such as the Stochastic Oscillator, and momentum.
Another aspect of technical analysis is that it can be self-fulfilling. If many investors and traders believe a certain price is important, they may use stop-loss orders at certain levels. That, in turn, makes it likely those points will trigger a reversal or pause in an asset’s direction.
Recommended: Technical Analysis for Stocks: The Basics
How Do You Identify Support and Resistance Indicators?
As discussed, the support level is typically a price point at which investors or traders expect a downward price trend to pause or reverse. A resistance level is the price point at which an upward price trend is expected to pause or reverse.
Here are some different ways in which support and resistance levels can be determined.
1. Round Numbers
Round numbers like $100, $500 or $10,000 can be levels at which investors, traders and analysts believe a price trend will hit support or resistance.
For instance, in a hypothetical example in the stock market, a company’s shares may climb steadily and struggle to surpass the $100 level. This may be driven more by market sentiment, as the market doesn’t believe the stock can consistently trade above that $100 level.
There could also be a more fundamental reason, such as the $100 level pushing the valuation–something like the stock’s price-to-earnings ratio–to a level the market believes is too expensive.
2. Buy and Sell Orders
Technical analysts may come up with support and resistance points by studying where buy and sell orders are congregated. In other words, they’re determining support and resistance levels by the volume of trades.
Investors, traders and analysts may have access to actual buy or sell order books. They could study price targets that bank research analysts set. They may also scour sources like social-media platforms to get a sense of where investors believe the stock may find a floor or hit a ceiling.
For instance, with Bitcoin, the chatter on a social-media platform like Reddit or Twitter may indicate the $30,000 level is where the cryptocurrency may find a bottom. Those in the market may use that to believe that’s a “support” level for Bitcoin.
3. Historical Highs and Lows
A previous high or low for an asset may be deemed a level at which there’s support or resistance.
For instance, let’s say Company Y stock had months ago climbed to hit a price level but then reversed. If Company Y stock nears that level again, investors may believe that’s a resistance point where the shares may struggle again.
How to Trade Using Support and Resistance Levels
There are roughly four types of investors who may be using trade and resistance levels:
1. Investors who are long and waiting to buy at a support level,
2. Investors who are shorting a stock or asset and may close their position,
3. Investors on the sidelines and want to buy at a support price,
4. Investors on the sidelines and simply monitoring to learn more about the stock.
One common way investors and traders utilize support and resistance levels is through stop-loss orders. Stop-loss orders are in general popular when it comes to technical analysis trading. They involve placing an order with an investor’s brokerage account to buy or sell once an asset reaches a specific price.
Stop-loss orders are a way for investors to manage their portfolio without having to monitor their holdings every day.
For example, let’s say an investor believes $1,000 is a level of resistance for Company Z stock. They could set a stop-loss order to sell the stock at $1,000, which the brokerage firm will automatically execute once the shares hit that price.
Support and resistance levels are price points at which investors and traders in a market expect trends to reverse or take a pause. Individuals can think about support and resistance levels as the potential floors and ceilings for price moves in an asset.
While there’s no guarantee support and resistance levels come true, it can be a helpful way to try to time the market or have specific price points to monitor. They may also use these prices to gauge whether the velocity of a price movement will slow down, pick up or reverse course.
Investors can track support and resistance levels and employ technical analysis by monitoring their holdings on the SoFi Invest® brokerage platform. The Active Investing platform allows users to buy and sell company stocks, exchange-traded funds (ETFs) and fractional shares with zero commissions. SoFi Invest users also get access to certified financial planners who can provide investing advice for no additional costs.
Photo credit: iStock/Jay Yuno
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