Basic Technical Analysis
Support & Resistance
Support and resistance levels are, without a doubt, two of the most widely debated aspects of technical analysis. It is helpful to think of prices being established within markets due to a head-to-head battle between buyers trying to force prices higher (commonly referred to as ‘bulls’ in financial markets) versus sellers trying to push prices lower (widely referred to as ‘bears’). Therefore, the direction in which prices moves indicate whether bulls or bears are in control of the market. However, buying and selling power is not equal at all prices, which gives rise to Support and Resistance levels where control shifts from buyers to sellers or vice versa. This is shown in the diagram below:
The chart above shows that the EUR/USD futures contract fell to the 1.2999 price level multiple times before buyers eventually took control and prevented prices from moving lower. This means that at prices around 1.2999, buyers were willing to buy, and sellers were unwilling to sell – resulting in market Support at 1.2999.
Similar to Support, Resistance levels occur at price points at which sellers take control of prices and prevent them from moving any higher. This is illustrated in the chart below:
In the EUR/USD futures contract again shown above, selling power exceeded buying pressure on at least four occasions from May to Jun 2012, around a price level of 1.2417, before the market eventually broke higher. This means that at prices around 1.2417, sellers were willing to sell, but buyers were unwilling to buy – resulting in market resistance at 1.2417.
However, with investor sentiment changing over time, support and resistance levels cannot be expected to remain indefinitely, leading to what is known as break outs above resistance or below support. This is illustrated in the following chart below:
Using the previous example of support at 1.2999 on the EURUSD futures contract, we see this key level held until early May 2012, when prices finally broke through conclusively to the downside. This was also accompanied by higher volume, as indicated on the volume bar chart below, which shows that the move down was on the back of significantly higher selling pressure. This downside breakout resulted in the market moving successively lower, forming a low of around 1.2300 before having a retracement backup.
The development of support and resistance levels is probably the most noticeable and reoccurring event on price charts. The penetration of support/resistance levels can be triggered by fundamental changes above or below investor expectations (e.g., changes in earnings, management, competition, etc.) or by a self-fulfilling prophecy (investors buy as they see prices rise). The cause is not as significant as the effect–new expectations lead to further price levels.
