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Support and resistance

The trend is composed of a series of peaks and troughs that move up, down or horizontally. Those peaks and troughs represent support (trough) and resistance (peak).

Support is defined as an area on chart in which the purchasing power is so great that it overcomes sales pressure. Therefore prices are reaching the line of support, but do not go below it.

Support and resistance
Support and resistance

Resistance is quite the opposite term of support, the area on chart in which the selling power is so great that it overcomes buying pressure.

In upward trend, each line of support must be greater than previous and each line of resistance must be greater than the previous one. If price changes during correction to level of previous minimum this can be considered as early signal that the upward trend will invert or at least turn into a horizontal trend. The logic is similar with the line of resistance: if the top fails to reach the previous peak this can be an early signal for trend change.

When the price of financial instrument breaks support or resistance line, often happens that support and resistance replace their roles. If the price falls below the support line for 3%, then it becomes the lines of resistance, and creates a new support line is created. Similarly, if the price rises above the resistance line for 3%, then it becomes a support line. Whole process must be confirmed by volume. Breakthrough of resistance line should be seen with initial increase of volume, while breakthrough of support line should be seen with initial reduction in volume and further increases as price falls. Be aware not to fall into the trap, because it may happen that after a break of the line, prices go back to the level where they were before.

Why prices are oscillating between support and resistance lines? For example, let's say that for some security, there are three types of interested parties: those who make long positions, those who short and indifferent participants. Suppose that the price is moving towards the resistance line.

Those who make long position already bought security and they are unhappy because they have not bought more, because their assumption was good. Now they are waiting for the price to return back to where it was, to buy more.

Traders who have decided to short, realize that they are on the wrong side. They would like that price pull back to the level of support to buy and to reduce or neutralize the loss.

Indifferent participants can be divided into two groups: those who once had a position but for some reason they have closed it and those who have never had a position on this security. Participants who have already had a position now regret and they hope that the price could go back where it was, to buy it again. Those who have never had a position recognize that prices go up and waiting for the moment of drop to open the position.

Therefore all participants would like that price level back to where it was, on the level of support.

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