Support - Resistance: Charting terminology

Today I shall talk about a very basic but one of the most important topic when it comes to reading charts of a particular stock/index/commodity or any other trading asset class with good liquidity - Support and Resistance Levels. 
The meaning and application of these terms is what I shall try discuss by way of this post.

To simply put it, support is any level where the buyers start entering a scrip (a trading asset) thereby preventing it from falling below that level.Similarly, resistance is any level where the sellers are greater than the number of buyers and they push the prices down, thereby preventing the stock from surpassing a particular price level.

Lets say the price of stock A moves from Rs. 100 to Rs. 130 in 1 month. In the next 1 month, the stock price falls back to Rs. 115. The price stays above 115 levels for the next few weeks before rising to Rs. 150. What exactly happened? The buyers initially pushed the prices from Rs. 100 to Rs. 130. At Rs. 130, the sellers emerged and they pushed down price of the stock. Rs. 130 thus became a resistance level for stock A. However, the sellers could only push the stock to Rs. 115, where demand for the stock reemerged and pushed the prices above. This 115 level is thus a support level for stock A. 

What about Rs. 130 level now? Is it no longer a resistance? Well, once the stock manages to cross Rs. 130 level, its a victory for the buyers. In future, they will protect the stock from falling below this level in case it falls again. Hence, it can be said that the earlier resistance level, once crossed, now becomes a support level for stock A.

Let us now try applying this concept to a real time chart of a stock. The image below shows the 2 year chart for Reliance Industries. I have personally traded this stock twice in the last 1 year using just the basics of support and resistance. Let's see how. (Chart created using Zerodha software)

At the start of 2015, the stock tried to move above 920-930 levels twice but failed to cross these levels. This level of Rs. 920-930 thus was a resistance level for the stock. However, in June 2015, the stock finally broke the resistance ( often termed as a "breakout") and took hardly any time to move to 1070-1080 levels as can be seen in the chart above. This is the power of a major break out above a resistance level and is often used by short/medium term traders to make quick gains. 

Next, the stock faced selling pressure at 1070 levels and the prices were pushed down back to the previous resistance level (now a support) of 920-930. But the selling pressure was so huge that stock fell even below the support of 920-930 (often termed as a "breakdown" ) and took no time to test even 820 levels. Fall below a major support level (which was earlier a resistance) is also used by traders to make quick gains through short selling.

Since then, the stock has continuously been in a range as can be seen in the chart. It was this range that helped me catch a 13-15% not once but twice in a matter of 10 months. There is a strong support for the stock around 920-930 levels and huge resistance around 1080-1100 levels. I bought the stock every time it came near to 920 level (with the caveat to exit the position with small loss in case it goes well below 900) and sell every time it came close to 1100 level (with the thought of buying it again in case the stock breaks out above the resistance level of 1100.

Though the concept may seem too simple, it works out really well. The Novice traders especially, should use this to know entry and exit levels while trading. Entering and exiting near support and resistance levels gives the trader a great risk reward. In the above case of Reliance Industries, we see a support at 920 level for the stock. Buying near 920, with a stop loss around Rs. 900 or even 890, gives a risk of Rs. 20-30. The trade has a potential of reaching 1070-1080 level, i.e. a return of about Rs. 150, thus giving a risk- reward ratio of 1:5-1:7. 

This concept can also be applied on shorter term charts of stocks and indices. We have taken the  daily chart of Reliance for 2 years. A short term trader may use hourly , 30 minute or even 15 minute charts to find small support and resistance levels and make money in the very short term. This is only one way of understanding supports and resistances. Often, there are trend line supports and resistances too which I shall cover in upcoming posts. Till then, try applying or noticing this concept on other scrips.

Happy trading

Cheers!