Structure continued…… Support and Resistances..
In the previous post, we have discussed the importance of structure when the future is uncertain. And we also know that the market has memory and inertia as it is the replication of traders making trading decisions all the time in the market. If you have missed it, please find it here before proceeding further.
Have a look at the above figure once. Suppose a person has bought the shares at point 1. Just try to understand his emotions throughout the journey of price from point 1 to point 4 (assume that the right-hand side of the drawing is not there when you are moving from point 1 to point 4 to get the feel for the uncertain environment). At point 1 when he bought the stock, he will be eagerly waiting for the stock to move up. When it starts rallying to the upside, he will be like, ” Ohh.. cool… I am good at predicting the future. This is going to be a winner. ” with a big smile on his face. He maintains that smile till point 2 as the stock has never seen back from point 1 to point 2. When it starts to move down from point 2, he will be mad at himself for not exiting the trade at point 2 and now waits for the second chance to exit if the market comes back to point 2 again. He waits and waits for that chance to exit, which never comes until point 3. At point 3, he is in extreme stress as the price is almost at his entry point and he has given back all his profits made. If you are in his position, what are your immediate thoughts?? How do you feel when the stock price starts to raise from point 3 to the upside. If you are smart, you will look for the immediate exit when the price reaches point 4 without any hesitation as it has taken a U-turn in the past ( at point 2). What happens if a large number of people has gone through this emotional cycle while the stock travelled from point 1 to point 4? They all look to exit at point 4 for the same reason I have explained above, and they all prepare their sell orders at point 4 for the exit. This sell orders will push the price to the downside after point 4. This process repeats again and again until there is enough buy orders to dominate the sell orders at point 4. resistance1
This is how it looks like. Every time it hits the top point, you can expect some selling there. The above level, that is objecting the movement of price is known as Resistance.
The same happens when the price is moving down, and the resultant picture will be like this.
The bottom line is known as Support.
Some say that support and resistances are a self-fulfilling prophecy. A self-fulfilling prophecy is defined as follows:
“ If a greater proportion of the crowd say something is true, it will become the truth irrespective of the background information“.
If 90% of the traders believe that the support and resistances work, they will make the decisions depending on their beliefs and hence generate the net order flow to drive the price in a particular direction.
No matter what the reason is, we know support and resistances work and we can use them to our advantage. You don’t need to remember the whole psychological thing explained in this article as I have written it just for your understanding.
Just remember the following points,
Resistances are the roofs for the stock. They oppose the upward movement.
Supports are the floor for the stock. They oppose the downward moment.
Assume you are there in a room and trying to jump up. What is the maximum height that you can reach?? Of course, the roof as it opposes the further movement to the upside. The same is true for the floor.
Now you must ask this question. Is there a possibility for the support and resistance to breaking. Of course, there is. Let’s get back to the above room example once again. But now, instead of you, assume, the incredible hulk is jumping inside the room. 😀 , There is no way that the normal roof can oppose his strength. The roof will be broken and he continues to move in the upside direction.
The same happens in the market. If the net order flow that is trying to push the price of the stock higher is strong enough, the resistance will be broken. Similarly, if the net order flow that is trying to push the price down is strong enough, the support will be broken. And the support or resistance once broken changes its polarities, ie. support becomes a resistance in future and the resistance becomes support in the future. Observe the following pictures for a better understanding of this explanation.
In the first image, the support is broken and now it will act as resistance in future.
In the second image, the resistance is broken and now it will act as support in future.
But remember one last important point, support and resistances are levels, not lines. ie. you can say that there is a support level between 300 and 303, but you cannot say there is a support at 300. I may use them later during explanations of concepts in this blog, but please remember, whenever I say there is a support, please understand that it is a level.
Now lets get back to the base concept where we have started all this. ie. Structure.
I restate that here again as a review and information consistency,
Price moves in a structural framework of Support and Resistance
1. If the framework is broken, it will enter into the new framework with a polarity shift in support/resistance.
2. Just understand what are supports and resistances for now. Don’t go deep into the construction of them as I have not explained it yet. This structure topic is not yet done. We will go into the details of how I create this framework in the next article. Until then, goodbye. :
Resistances act as roofs for the price movement.
Supports act as a floor for the price movement.
Support once broken turns into resistance for the future price movement.
Resistance once broken turns into support for the future price movement.