For the last few weeks, the Nifty has largely been trading in the range defined by its support level at 7,800 and resistance level at 8,100. Support and resistance levels are very commonly used terms in share trading. In simple terms, support is the price level below which a scrip or index does not often falls and resistance is the price level which the scrip of or index does not often exceed. The chart below shows the candlestick chart of the Nifty from August 1, 2014 to September 30, 2014. A candlestick chart is so called, because the intraday price movement is depicted by a candle. The body of the candle shows the open and close price (white if close is higher than open and black if close is lower than open) and the wicks at the top and bottom of the body show the intraday high and low prices.
The chart shows a support resistance pattern formation for Nifty after August 20, with support level near 7,900 and thereabouts. The resistance level has formed at 8,100 are thereabouts. For the last month Nifty has been trading largely within this range and has struggled to break out on either side.
While many investors are familiar with the concept of support and resistance, one needs to understand these concepts in greater depth in order to use these levels to trade profitably. Trading based on a superficial understanding of support and resistance is risky as these can lead to losses. In this blog, we will discuss various characteristics of support and resistance levels without going into the intricacies of technical analysis.
Support and resistance are formed because share prices have memory. These are price points where a significant number of buyers and sellers would have participated in the past. When the share price retraces to those points, significant number of buyers and sellers participate again with similar effect. Let us understand with the help of an example. Let us assume that a scrip is trading at र 100. If the price of the scrip suddenly falls to र 80, some investors will feel that they lost the opportunity to sell the scrip at र 100. So they will wait for the scrip to go back up to र 100 and when the scrip reaches र 100, these investors will short or sell the scrip, preventing the scrip for rising further. Therefore र 100 becomes the resistance level for the scrip. Similarly, investors who could not buy the scrip when it fell to र 80 will feel that they lost the opportunity to buy the scrip at र 80 and make a profit. So when the scrip comes back to र 80, buyers will flock into the market to buy the scrip, preventing the scrip from falling further. Therefore in essence, support and resistance are important psychological levels for demand and supply of a scrip. When the scrip reaches the support level demand increases and when the scrip reaches the resistance level supply increases.
Determining support and resistance levels falls requires the expertise of a technical analyst. However, retail investors can get these levels both for individual scrips and the indices (e.g. Sensex, Nifty, Bank Nifty etc.) from various sources. Financial newspapers, journals, business news channels frequently mention these levels for scrips and indices. Brokerages also issue technical guidance on support and resistance levels of various scrips and indices from time to time. Investors can also subscribe to technical analysis services. Knowing support and resistance levels is critical to the success of short term equity investors or traders. Investors should be more alert when the scrip starts trading near their support or resistance levels. Price of scrip usually bounces from support levels and rebounds from the resistance levels. So the strategy is usually to go long (buy) at support levels and go short (sell) at resistance levels. Intraday traders usually adopt this strategy, also known as channel trading. Investors should not place buy or sell order exactly on the support level or the resistance level. This is because the price gets close but usually does not reach the support or resistance level. Many investors wait for a breakout from support and resistance levels, to take long or short positions depending on the direction of the move. This is usually a more sound investing strategy.
Despite the Reserve Bank of India (RBI) policy announcement, the Nifty closed today (September 30 2014) at 7,965. The Nifty seems to consolidating for the time being. As discussed earlier 8,100 is the major resistance level for Nifty and 7,800 seems to be a good support level. It will probably take a major development or strong Q2 earnings growth story for the Nifty to breakout from the 8,100 level. The all time high of the Nifty is 8,180. So if the Nifty breaks out of the 8,100 level and manages to cross the all time high, then much higher levels are possible on the Nifty.
Conclusion
In this article, we discussed several aspects of support and resistance levels, two very important concepts in equity investing. Investors should educate themselves about these levels and use them intelligently while making their investment or trading decisions, so that they can maximize their profits.
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