It is that level of a stock, below which prices do not fall for the time being. It acts like a floor where the price gets support and rebounds upwards. It assumes importance when prices are falling.
Suppose we look at the price action of a stock. For example, price of ABC Ltd is falling and each time it falls it does not fall beyond Rs 140.65. Buyers understand that may be this stock is strong enough not to fall further and maybe it is worth buying the stock at the support. If we look from seller’s side, we can interpret that sellers are not willing to sell the stock at less than Rs.140.65. So stock price do not fall further. Support is a level where there are more buyers than sellers, who keep the prices from falling further. These buyers always think that the price will rise now and hence either they don’t sell or they keep buying.
For example, from current data on NIFTY, we observe three levels of support as shown in Figure 1. These are 4792, 5172 and 5349. The 5349 level of support was also observed in August 2010 and can be taken as a medium term support. If this is broken, then a short term support can be 5172. If this is also broken, we are looking at a support at 4792 levels. This is how market movements are analysed and trends understood.
Figure 1
Resistance
It is that level of a stock, from where prices of the stock may not go up. It acts as a roof for the time being. Prices are expected to hit this roof and fall. It assumes importance when prices are rising. It gives an estimate as to up to what level prices can rise under the prevailing scenario.
The price of ABC Ltd is rising and each time it rises, suppose it fails to rise further than Rs.210.40. In this case investors think that, whenever the stock reaches this price, it may fall, prompting them to sell the stock. Further, buyers wait for the prices to fall to pick it up cheap later. Thus there is selling pressure and little buying interest leading to fall in prices from this level.
Consider the example of Reliance Industries Ltd. as given in Figure 2.
Figure 2
We observe 3 resistance levels. One at Rs. 1152, the second at Rs. 1091 and the third at Rs. 1055. It can be clearly observed from the diagram that these levels are working as ceilings and the subsequent resistance levels have also fallen. This indicates, that for the time being, a trend reversal will not be observed. Investor expectation of prices to fall further may actually push prices down.
Support and resistance levels helps an investor to understand trend in technical analysis. In an uptrend, resistance levels keep changing and every time a new resistance is created. And similarly with the support level in a downtrend, every time the price of the stock falls, a new support is created. In other words if a breakout happens there can a trend reversal. For example if support level is violated then the trend may reverse from and uptrend to downtrend and vice versa with resistance.
It is also possible that support becomes resistance and resistance becomes support. When resistance becomes support, this indicates an uptrend. Similarly, when price drop below support level, that level becomes a resistance level and indicates a downtrend. An example is given in Figure 3 where support at Rs.680 in October – December 2010 has become resistance in March 2011.
Figure 3
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