Monday, August 26, 2013

Support and Resistance levels


What is Support and Resistance levels in share trading?
      Creating a smokescreen of mystery by using  confusing words abundantly in the talk and deliberately making a concept that we have been speaking about something big.  This is the activity of at least a few of professionals nowadays.  They deliberately wish to hide the matters under the fog and fumes.  For that, they never forget to use a lot of technical jargons in between their talks. And the listeners, probably, didn’t understand the talk though, avoid asking their basic doubts in order to keep their ignorance hidden from public.  


     One guy, once, had to give more reverence to his preceptor as he must be greater than Sri Budha who died at age 80.  The guy used a trick, for which he didn't hesitate to say, his preceptor was born (not died) at age 84.  Look, what he irrationally claimed is that his preceptor was born at 84.  What a blunder!  Yet the guy was left without questioning.

     Once, when the Sensex nosedived from 21,000 by 10,000 points, another guy, who was traveling in a train, told to his co-passenger.  ‘Sensex will reach 5,000 level in one month.’ The later was astonished and subdued by anxiety.  He had bought some shares, thinking that it was the best opportunity, when the Sensex nosedived from 21,000 to 15,000.  But in the followed torrent, opposite to his expectations, Sensex again fell steep beyond 10,000 and his loss was estimated more than 50% of his capital.  It was in that context the co-passenger’s comment that the Sensex is expected to be going down towards 5,000 levels.   Panic triggered in his mind and he asked a bit loudly.  “Are you saying that the Sensex will nosedive again and will reach 5,000 level?” 
“What to doubt!  I hope to buy some shares at that level”.  Hearing this answer, our guy really shocked and asked.  “If it is so, let me sell the shares now and re-enter at the lower levels. Wouldn’t it be better?”  The reply was just a smile with nod.

     But after one and half year, when the share prices reached more than double of his buying price, with deep depression, he said.  “If I was patient enough to hold the shares, without giving attention to that co-passenger's words, now, I could have earned 100% profit now instead of 50% loss of that time.”  But the then co-passenger who had spoken about the share market in an authoritative tone, now said. “What I had said was correct. I had said that the Sensex would reach 5,000 level only in case it breaks the support level 7,100.   In that sense, today, I hope that the Sensex will touch 20,000.  But only on condition that it must break the resistance level 16,400!  Hearing this, the guy didn’t continue the conversation on that topic. It was obvious that, then, he was not interested to clear his doubts about the support/resistance levels in the presence of others.   The person who talked these matters may not have possessed much knowledge about this topic though, his intention was fruitfully executed.  He escaped from the further questioning that why the market moved towards just opposite direction of what he had predicted.  Speak with more and more technical jargons when you don’t have the clear answer. This has become a phrase too nowadays.

     Despite we have heard the term support-resistance levels many times, did we really understand about those levels?  Many investors, at least, didn’t understand how the levels are formed.

     If anyone asks you to climb a steep hill quickly, in an initial excitement, you might rush ahead as quickly as possible.  But after a few steps, you will get tired and start panting.  Therefore, you will relax for a while and accumulate energy for further movement.  Exactly this is what the support-resistance level.  These levels don’t mean that the share price will never go upward beyond resistance level nor will go downward beyond support level.  But rather, there, a resistance will form at that level.  For example, when you climb a steep hill, you will relax there for a while and resume the journey after getting rejuvenated.  In the other case, you will climb down when you see the further climbing is more difficult. 

     Now let’s see how a support-resistance level is forming in share prices or bourses.  It is just based upon the sentiments of investors.  Suppose an investor bought a share at the price Rs 200.  Trading volume of that share also was very high at that time.  But against the expectation, this share price reached at Rs 160.  The trading volume also has come down.  When the price was at Rs 200, the trading volume was very high. Which means, the investors were optimistic about the share at that time.  But when it fell down to Rs 160, a number of investors who bought the share at Rs 200 are not satisfied about the performance of the share.  Subdued by anxiety of more loss, the investors will sell the stock again and again. which will lead the share price to more declining.  

     But in the other case, if the share find bottom at Rs 160, when the share price starts gradually going up, again, the investors are attracted on this share and more and more buying will be executed.  Which will lead further increase in the share price.  Again when it reaches at Rs 200, a big  group of investors will start selling the share in the memory of their previous experience. (Last time it was at Rs 200 the share price started declining). 

     Once, more sellers are coming forward to sell at this level, the share price will, either stay there for a while or will start falling down.  That is the resistance level of a share.  Again, when the share price fall and reach at Rs 160, in the memory of previous experience (share price had found bottom at Rs 160 last time) investors start buying the share.  That will lead to stay the share price at that level or will start gradually going up.  That is the support level of a share.

    We took the example of only one share though, the matter is same for all shares as well as indices.

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