What is Resistance?
What is Resistance?
What is resistance?
Resistance is one of the fundamental elements of technical analysis (along with its corollary--support). Resistance is a price or price area above the current market in which an asset is expected to move in the upside. Resistance is where selling interest appears over time, blocking further progress.
Resistance can be a single price point, such as the day's high, or the hourly high. Resistance can also be a zone, meaning an area with multiple points, such as $0.50/$1.00. A resistance zone represents a test of a resistance level, which can be broken by a small amount, but eventually returns price growth, essentially leaving the resistance level intact. This could also be interpreted to mean that there is even more supply around the resistance area, potentially indicating a reversal to the downside.
Resistance can be found on any time frame of chart analysis, where a longer time frame (daily or weekly) suggests a more important, multi-day resistance level, while a shorter-term chart (hourly, 30 minutes) only May show minor resistance (good for day-traders).
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Key Takeaways
- A resistance level represents a price point or price area that an asset has had trouble breaking above over the time period being considered.
- A resistance level can be several points wide, due to multiple attempts to break above the resistance, potentially creating a resistance zone and sending prices lower.
- Trendline analysis is a simple yet powerful method for identifying areas of resistance; While other mathematical methods are also often used.
- Resistance levels are important to identify for several reasons: where to place stops for short positions; Where to place take profit orders for long positions, and when to enter long positions on a resistance break (a breakout trade).
How Does Supply and Demand Affect Resistance?
The demand for an asset is that which over time absorbs the market supply and outpaces it. Liquidity refers to the total amount of supply and demand at any given time. High liquidity is likely to limit the overall volatility of share prices, while low liquidity can cause prices to move excessively, potentially creating a divergence. The source of demand can be a piece of macroeconomic news, such as remarks from a Fed official or an earnings release. After a series of gains, however, demand may eventually subside or stop altogether, as the 'buying spree is over.' If the price forms a top, it is now close to a point or resistance. acts as a field.
Supply can come from a number of sources, such as profit-selling around a resistance point or area. Another example is where the option holder wants to hedge his option position by selling a lot of shares at a specific price point before resistance. And of course, macro news can pull traders to short the market for a specific stock or other asset if negative news emerges, trailing a resistance point in its wake.
Resistance Is Made To Be Broken
Using technical analysis, traders can identify a particular point or area of resistance. That resistance zone is likely to be tested in the middle of the uptrend. If the trend and buying interest are strong enough to challenge a resistance point, traders may find that the resistance zone breaks, bringing in more breakout buyers. Stop loss buy orders can also come into play above the resistance area, bringing in another source of buying, and clearly breaking the resistance.
After overcoming a resistance point, it is not uncommon for sellers to briefly test below the breakpoint to see if it holds. If this happens, traders are likely to conclude that the break of resistance is valid and play to the upside. This is an example of a broken resistance level turning into support. Known as the polarity principle, once resistance is broken, it becomes support, and vice versa. Whether this is now major support or minor resistance depends on the time frame. A break above the recent daily high is more bullish than a break above the one-hour resistance.
Trading Using Resistance
Once a point of resistance is identified, the agile trader can try to sell short when the particular resistance point approaches, say $105/share, or take profits on existing longs at or near $105. Both new sources of supply potentially strengthen resistance. point. For those traders who went short ahead of resistance on speculation, they may be looking to buy back once the anticipated decline move ends or ends.
If price moves higher to test the resistance point, they can fill profit-taking sell orders, reducing one source of supply. If speculative short-sellers also get their orders filled, another source of supply is now gone. Most likely, the short-sellers might have left a stop loss buy order above the resistance point or area, allowing margin of error for slippage. If the uptrend continues and eventually breaks above the resistance level, those stop loss buy orders can be triggered, generating a new source of demand that pushes the price higher. Alert breakout traders may enter the market on the buy side, adding another source of buy demand.
Identifying Resistance Levels with Trendlines
Trendlines are powerful tools for analyzing a security's historical price action and identifying resistance levels. The chart below shows the hourly view of NVDA. Note how an hourly top is formed at 220.00/50, and is subsequently broken, leading price to 230.00/50, which it tests again and forms a double top in the process. Also, note that the 220.00/50 later becomes a pivot line, acting as both support and resistance on several occasions, respecting the polarity assumption, broken resistance becomes support and vice versa. Adverse.
In the daily NVDA chart below, we can see how trendline and fundamental pattern identification can provide important price signals and trading opportunities. To the left, a double top pattern is forming over several days, suggesting a top and opening downside potential. The lower lows form a horizontal trend line that persists after the price fails again at the $190/share level. The price eventually tests the $140/share trendline level which holds, and the price moves into a strong upward channel, breaking above the key resistance at $190 and extending to the $230/share level, where another A double top is formed which suggests that the uptrend is over. there is time.
Attentive readers will have noticed that the resistance levels encountered above are major, large-rounded numbers such as 140, 190, and 230. These are often referred to as psychological 'big figures', meaning that traders pay attention to these levels as potential areas of support. and resistance. On their own there may not be a good reason to pay attention to them, but the psychological behavior makes them a potential resistance level.
Identifying Resistance Levels With Trading Systems
There are several different technical tools that can be used to identify potential resistance levels based on mathematical formulas. To name a few of them are Simple and Exponential Moving Averages (20,50,100 are preferred), Ichimoku or cloud charts and Bollinger Bands.
Below we have an example of a daily NVDA chart with Bollinger Bands attached. The Bollinger Bands are momentum indicators set at 2 standard deviations from a simple 20-day moving average in the center. As you can see, the upper Bollinger bands tend to have price moves during the weeks, giving traders an up-to-date upper resistance band. That level can be used to take profits on long positions, while the moving average in the middle identifies the overall trend.
FAQ's
What is resistance?
Resistance is a price point or price area that serves to limit gains in a security due to supply exceeding demand.
How do I identify resistance levels?
Resistance levels can be identified through technical analysis of charts and the various tools that accompany them. The favorite tools used to identify resistance levels are major highs, trendlines, moving averages (simple and exponential), Bollinger Bands, and Ichimoku or cloud charts.
How do I trade with resistance levels?
It depends on your position and market outlook, as resistance will eventually be broken at some point. An aggressive trader may short just below the resistance level, looking for a pullback or reversal lower, essentially speculating that the resistance will hold. If it breaks, the same trader can also place a stop buy order above the resistance area. A breakout trader may jump to the long side if the resistance zone is breached. A trader who is long may want to place a take profit order to sell near the resistance area.
What is polarity principle?
Polarity principle refers to the price phenomenon whereby once resistance is broken, it becomes support and vice versa. A break of a resistance zone is usually a quick test of the breakout level to see if the break lasts, or if it fails and turns lower.
Last Line
A resistance point or zone develops when prices are unable to move above that zone. Resistance levels can be found on short-term or long-term charts, with longer-term resistance levels carrying more weight for the overall direction of the next move in the security. Resistance levels are identified by technical analysis or visual inspection, using tools such as trendlines, horizontal lines, moving averages and Bollinger Bands.
From a trading perspective, resistance levels provide various trading opportunities. You can go with the flow and buy in a resistance zone, looking for a break higher, you can jump on the long side once the breakout occurs, or you can look to sell in a resistance zone, going lower , taking the view that the resistance will hold and the price will move down. Whatever your position, once the price nears the resistance zone it is time to focus on price action and subsequent opportunities.