Understanding Support and Resistance in Charting

A Look at the Markets - Nvidia

Nvidia reported earnings on Wednesday (28th) this week and I always find it interesting to see the market reaction. The price was down around 10% yesterday (Thursday 29th August), the day after earnings.

While the earnings slightly beat expectations there are concerns that growth is slowing. This is only to be expected after the recent growth Nvidia has had due to supplying chips for the AI industry. At the time of writing, the price has reached support. Will it break through or does this represent a buying opportunity?

Understanding Support and Resistance in Charting

Over the past two weeks, we have examined charts and the indicators I use to analyse them. This week, I want to delve into the fundamental concepts of support and resistance, two critical elements in chart analysis that every trader and investor should understand.

What Are Support and Resistance?

Support and resistance are key price levels on a chart where price action may pause or reverse. These levels are crucial for traders and investors as they help in making informed decisions about when to enter or exit a market.

• Support: This refers to a price level where a falling asset may find a "floor" and potentially reverse direction. When an asset's price is dropping, traders look for areas of support as potential points where buyers might step in and drive the price back up.

• Resistance: On the flip side, resistance is a price level where a rising asset may hit a "ceiling" and begin to fall. When prices rise, investors look for areas of resistance where sellers might enter the market, causing the price to drop.

What Causes Support and Resistance?

The creation of support and resistance levels is influenced by market psychology and the balance of supply and demand. When prices reach certain levels, they can attract buyers or sellers based on historical price action, market sentiment, and other factors. Let’s explore these concepts with some charts.

Analysing Support

In the chart of AstraZeneca below, you can see horizontal levels of support. Notice how, in the past, when the price action has fallen to these levels, buyers have entered the market, causing the price to rise. This is because more buyers than sellers create upward pressure on the price. However, it’s important to remember that support levels are not impenetrable barriers—they are guides that indicate potential buying zones. In fact, we can see that price action penetrated the support line in July 2024 but quickly retraced above it.

Understanding Resistance

Similarly, the next chart, Bitcoin, illustrates horizontal levels of resistance. As the price approaches these levels, in this case around 72,500 dollars, sellers often enter the market to take profits, leading to a price decline. If there are more sellers than buyers, the price falls. Just like support, resistance is not a rigid barrier but a zone where selling pressure might increase. Will the Bitcoin price breakthrough? Time will tell!

Support and Resistance Are Not Always Horizontal

It's also crucial to recognise that not all support and resistance levels are horizontal. In a rising market, trend lines or simple moving averages can act as support. Both are present on the chart of Nvidia above. Conversely, in a falling market, these same trend lines or moving averages can serve as resistance.

Using Support and Resistance in Trading

Traders and investors frequently use support levels to identify buying opportunities. In a falling market, if no clear support level is evident, I often wait to see if the price drops further before making a purchase. Of course, this strategy carries the risk that the price might reverse before reaching a support level, causing me to miss out on the trade.

Similarly, resistance levels can help in deciding when to sell. I sometimes use these areas to determine whether to take partial profits—a strategy that involves selling a portion of my investment. This approach carries the risk of missing out on further gains if the price continues to rise, but such risks are inherent in investing.

The Dynamic Nature of Support and Resistance

One interesting aspect of these levels is that they can switch roles. A former resistance level, once breached, can become a new support level. When the price revisits this area from above, it often presents a new buying opportunity.

We can see this on the chart of the Swiss Franc against the Japanese Yen, above. Between January and April of this year, there was an area of resistance, around 171. Price briefly broke out at the end of April before dipping below (a false break out). Price then broke resistance again in early May and this time the area of former resistance became support towards the end of May. As it turned out, this would have been a great buying opportunity.

The Psychology of Investing

Investing is as much about psychology as it is about numbers. One way I use support levels is to anticipate where the price might fall, even when holding long-term investments. By understanding charts and predicting where other investors might sell or where buyers might re-enter the market, you can avoid being surprised by price movements and hold onto your investments with greater confidence.

Understanding support and resistance is essential for successful trading and investing. By mastering these concepts, you can make more informed decisions and navigate the markets with greater ease.

Words of the Day - Ceiling, Floor, Supply, Demand

Ceiling - noun - the part of a room you see when you look up

Floor - noun - the flat surface of a room on which you walk

Supply - noun - the amount of something that is available to purchase at a given time

Demand - noun - the quantity of a good that customers are willing and able to purchase at various prices at a given time