Skillsfirst Level 3 Certificate in Introduction to Financial Trading (RQF) - UNIT 1: Principles of financial trading
Skillsfirst Level 3 Certificate in Introduction to Financial Trading (RQF) - UNIT 2: Principles of Financial Planning and Cash Flow in Financial Trading
Skillsfirst Level 3 Certificate in Introduction to Financial Trading (RQF) - UNIT 3: Understanding financial trading techniques

BASIC TECHNICAL ANALYSIS – SUPPORT & RESISTANCE

It is useful to think of prices being established within markets as a result of a head-to-head battle between sellers trying to force prices lower (commonly referred to as ‘bears’ in financial markets) versus buyers trying to push prices higher (commonly referred to as ‘bulls’). Therefore, the direction in which prices moves provide an indication as to 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 following diagram:

As shown in the chart above, the EURUSD futures contract feel 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 occurs at price points at which sellers take control of prices and prevent them from moving any higher. This is illustrated in the following chart:

In the EURUSD 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 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 are known as Breakouts 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 resulting in the market moving successively lower, forming a low of around 1.2300 before having a retracement back up.

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 that are above or below investor expectations (e.g., changes in earnings, management, competition, etc) or by self-fulfilling prophecy (investors buy as they see prices rise). The cause is not as significant as the effect–new expectations lead to new price levels.