The terms support and resistance in this context refer to price levels for a given asset, where historical price action has been seen to be somewhat boggy – i.e.: there’s a large number of buyers and sellers at those price points, which causes the velocity of price movement in a single direction to be restrained.
Support is the term used for an area of the price range at or below the current price.
Resistance describes the same type of congestion in price movement at or above the current price.
The difference really between support and resistance is simply the perspective from which they’re viewed – from the perspective of a falling price (into support below) or from a rising price (into resistance above).
Why do such phenomena exist? An example will do nicely here. Lets say someone (an individual investor, HNWI, institutional money, etc.), who we’ll call Jim, buys in to an asset at a certain price – let’s say 100 shares at $41 each. Jim expects to see the price of these shares go up, but after holding for some time he sees they’re now down at just $34 a share.
Jim’s faith in the company he bought is waning with each day that passes, and he sees more promising opportunities to invest his money elsewhere, but he doesn’t want to take a loss on this position just yet. So he decides to wait to see what the company’s next quarterly earnings report will reveal about its revenue, profitability and future outlook.
The company reports better than expected earnings results, and the shares jump up to $39 as soon as the market opens. Jim’s excited by this price action, but because the quarterly earnings numbers were only a modest beat versus analysts’ expectations, he’s still more keen to sell this position and invest elsewhere once the price of this stock returns to the price he initially paid for them. Over the next few days the price pushes back up to the $41 mark and Jim sells his shares at break-even.
Jim wasn’t the only one caught in this position with this particular stock, however, as anyone that had bought into it over the 6-month period prior to Jim’s purchase would have also had an average per-share price of $41. Because many other investors also felt the way Jim did, they had also decided to sell once they’d recouped their losses. It’s the result of this selling pressure that causes the resistance above the upward-moving price action.
Of course, there are many reasons for people and organizations (and algorithms) to buy and sell, but the above example one example of why sticking points in price action can occur.
Continuing with the above example, a few months later this stock’s price is up at $53 after reporting incredible earnings figures, but its uptrend is short-lived due to unexpected geopolitical tensions affecting the sectors in which it sells.
Its stock price plummets more than 20% in a single day as investors get scared about the economic uncertainty that news headlines have created. But rather than continuing to drop in free-fall, the price finds support at around the $41 price point.
The investors that bought Jim’s stocks from him believe that the turmoil in the news is going to be temporary, and so they’re taking advantage of the fear in the market and doubling down on their positions that they’ve seen jump more than 20% in just a few short months, with the expectation that that price behaviour will be repeated but that this time they’ll have twice as many shares.
It’s this buying pressure that creates the area of price support in this example.
Support and resistance price patterns are extremely common, and can be easily identified on a chart. We’ll get some demonstrative images up here soon.