Support and Resistance Indicator

Support and resistance are basic ideas in technical analysis. Knowing what these terms mean and how to use them is important for reading price charts correctly.

Prices change because of supply and demand. When demand is higher than supply, prices go up. When supply is higher than demand, prices go down. Sometimes, prices stay the same when supply and demand are balanced. 

What Is Support and Resistance in the Stock Market?

A support line is a price level where a stock or asset usually doesn’t drop below. When the price gets close to this level, it often flattens out or bounces back up.

On the other hand, a resistance line is a price level that a stock can’t seem to go above. When the price hits this level, it often levels off or falls back down.

Analysts find these lines by looking at price trends where a stock has repeatedly failed to break through certain points over time. There is no exact formula for determining support and resistance, but traders use tools like moving averages to help identify them.

For example, if a stock (let's call it Stock X) reaches ₹75 five times in six months but can’t go higher, ₹ 75 is the resistance line. Similarly, if Stock X drops to ₹40 six times and then bounces back up, ₹40 is the support line.

Knowing where support and resistance levels are is important for deciding when to buy or sell stocks.

How to Draw Support and Resistance Lines

Here is a simple 4-step guide to help you find and create support and resistance lines:

Step 1: Gather Data Points

To identify short-term support and resistance, collect at least 3 to 6 months of data. For long-term analysis, get 12 to 18 months of data. Using more data will make the chart look more compact. This is why the two charts appear squeezed.

Long-term Support & Resistance: Best for swing trading.

Short-term Support & Resistance: Ideal for intraday and buy today, sell tomorrow (BTST) trades.

Step 2: Identify Three Price Action Zones

• The price paused after a quick rise.
• The price paused after a quick drop.
• The price sharply changed direction at a certain level. 

Step 3: Align The Price Action Zones

When you look at a chart from the past 12 months, you’ll often see many price action zones. The goal is to find at least three price action zones at the same price level. These zones must be spaced out in time. 

For example, if you identify the first zone in the second week of May, try to find the second zone after the fourth week of May. The greater the distance between the two zones, the stronger the support and resistance identification will be. 

Step 4: Draw A Horizontal Line

Connect the three price zones with a horizontal line. Depending on where this line is about the current market price, it will act as support or resistance.

Keep in mind that when you visually analyze support and resistance levels, there’s always some risk of error. The price level is more like a range or area rather than a specific point. It represents a zone that can act as support or resistance.

How to Find Support and Resistance Levels

Finding support and resistance levels is crucial for technical analysis in trading. Here are some common methods to identify these levels:

Historical Price Levels: Look at past price action on the chart. Areas where the price has reversed multiple times can indicate strong support or resistance.

Trend Lines: Draw trend lines connecting the lows (for support) or highs (for resistance) of the price action. These lines can serve as dynamic support or resistance levels.

Moving Averages: Common moving averages (like the 50-day or 200-day) often act as support or resistance levels. When the price approaches these averages, it may bounce off or breakthrough.

Fibonacci Retracement: Use Fibonacci retracement levels to identify potential support and resistance. Key levels include 23.6%, 38.2%, 50%, 61.8%, and 100%.

Round Numbers: Psychological levels, like whole numbers (e.g., $50, $100), often act as support or resistance due to traders placing orders at these levels.

Volume Profile: Areas where high trading volume has occurred can indicate strong support or resistance, as these levels attract more attention from traders.

Indicators: Tools like Bollinger Bands or the Average True Range (ATR) can help identify potential support and resistance based on volatility. 

What is the Support and Resistance Formula?

The formulas for calculating support and resistance levels using pivot points are:

Pivot point (PP): (High + Low + Close) / 3

First resistance (R1): (2 x PP) - Low

First support (S1): (2 x PP) - High

Second resistance (R2): PP + (High - Low)

Second support (S2): PP - (High - Low)

Third resistance (R3): High + 2 x (PP - Low)

Third support (S3): Low - 2 x (High - PP) 

Pivot points help traders find potential support and resistance levels for the current trading day. You can also use a horizontal line between two price points with the Fibonacci tool to identify these levels. Support and resistance are stronger at price levels where a lot of buying and selling has happened, as traders tend to remember these prices and may use them again.

Types of Support and Resistance Indicator

Support and resistance indicators are essential tools in technical analysis for identifying price levels where an asset tends to reverse direction. Here are some common types:

Horizontal Support and Resistance:

Identified by horizontal lines drawn at price levels where the asset has historically bounced (support) or reversed (resistance).

Trendlines:

Diagonal lines are drawn along the highs (resistance) or lows (support) of price movements, indicating the prevailing trend direction.

Moving Averages:

Commonly used moving averages (e.g., 50-day, 200-day) can act as dynamic support or resistance levels, where price may bounce or reverse.

Fibonacci Retracement Levels:

Horizontal lines at key Fibonacci levels (like 23.6%, 38.2%, 50%, 61.8%, and 100%) indicate potential support or resistance based on the Fibonacci sequence.

Pivot Points:

Calculated based on the previous day's high, low, and close prices, these points provide potential support and resistance levels for the current trading day.

Bollinger Bands:

These bands adjust to volatility and can indicate dynamic support and resistance levels, with the outer bands acting as resistance and support.

Channels:

Price channels (e.g., ascending, descending) can define areas of support and resistance based on the boundaries of the channel.

Market Structure:

Higher highs and lower lows can indicate significant support and resistance levels based on the overall market trend.

These indicators can be used individually or in combination to enhance trading strategies.