Resistance

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21 Aug, 2024

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Resistance in trading is a level at which investors believe that the asset price has reached a point of overvaluation, and they start selling their positions, creating a barrier to further price appreciation. It is a point where the selling pressure surpasses the buying pressure, leading to a pause or reversal in an upward price movement.

Resistance levels are usually identifiable through chart patterns, including horizontal trendlines, moving averages, or previous peaks in price action. When the asset price approaches this level, traders often anticipate increased selling activity, which may create a supply-demand imbalance and restrict further upward price movement.

Resistance Meaning

Resistance in asset trading is a level where investors believe that the asset price has reached a point of overvaluation. It is a level where the selling pressures start exceeding the buying pressure.
Investors start selling their positions at this level, creating an imbalance in supply and demand. As a result, the asset price cannot appreciate beyond the resistance level.
This level creates a psychological and technical barrier that restricts further increases in asset prices. It can stop or reverse an upward-rising market price movement.

How Does Resistance In Trading Work?

Resistance implies a situation in trading which restricts further upward price movement of an asset. It is based on the concept that market participants tend to sell an asset when its price reaches a level they perceive as overvalued. This selling pressure creates a supply-demand imbalance, making it difficult for the price to continue its upward trend.

When the asset price approaches a resistance level, traders who believe the asset is overvalued or anticipate a price reversal will likely start selling or short-selling the asset. This selling activity increases the asset supply and may outweigh the buying demand, resulting in the price trend pausing or reversing. Additionally, traders who previously bought the asset at lower prices may decide to make a profit near the resistance level, further adding to the selling pressure.

How To Identify?

Some standard methods to identify these levels are as follows:

Chart Patterns: Traders must notice patterns like double tops, triple tops, or head and shoulders formations. These patterns indicate a level where the price has previously failed to break through, suggesting this zone.
Trendlines: Investors can draw trendlines connecting the highs of price movements. When the price approaches the trendline and struggles to move above it, it can indicate this level.
Moving Averages: Plotting moving averages on the chart and observing where the price consistently stalls or reverses near a specific moving average can signify this level. This moving average can act as this level.
Previous Peaks: Identifying previous price peaks on the chart can help identify this zone. These peak points can serve as potential levels where traders may be inclined to sell near these levels again.
Volume Analysis: Investors may observe volume patterns near certain price levels. A significant increase in trading volume as the price approaches a level may indicate intense selling pressure and potential resistance.
Psychological Levels: Round numbers or price levels ending in zeros or fives often act as these levels. For instance, if a stock is trading at $100, it may encounter resistance as traders may be more inclined to sell at this psychologically significant level.

How To Trade?

Some approaches to consider while trading this level are:

Short-selling: Traders may open a short position near this level, expecting the price to reverse and move downward. This includes borrowing shares or contracts and selling them at the current price, aiming to repurchase them at a lower cost to profit from the price decline.
Place Stop-Loss Orders: Investors can place a stop-loss order slightly below the resistance level to automatically exit the trade if the price fails to break out and reverses, limiting the potential losses.
Wait for Confirmation: Some traders prefer to wait for a confirmed breakout above this level instead of anticipating a reversal before entering a long position.
Monitor Price Action: Investors must pay attention to how the price behaves near the resistance level. They can look for signs of hesitation or rejection, such as long upper wicks in candlestick patterns, multiple failed attempts to break through, or the formation of reversal patterns like shooting stars or bearish engulfing patterns. These patterns can provide insights into potential reversals.

Examples

Let us discuss a few examples:

Example #1

Suppose Dream Zone Company's stock had risen steadily over the last few months and peaked at $100 per share. However, each time the price approached $100, it encountered selling pressure, resulting in the price reversing and moving lower. This consistent selling activity near the $100 level indicates a specific level where the selling pressure exceeds the buying pressure. Investors perceive the stock as overvalued or facing selling pressure at that price. As a result, they start to sell their positions. This is one of the resistance examples.

Example #2

On June 5, 2023, the Nifty 50 Index in India was anticipated to encounter resistance around 18,650, a close above this level, signifying a potential breakout. Breaking below 18,440 could result in further downside pressure, with support expected around 18,100. A close above this level would indicate a potential breakout and could pave the way for new highs, with the next target at 18,888. If the index continued to rally, the next target would be 19,400. This is one of the resistance examples.

Chart

Let us look at this Nifty Pharma 4-hour chart to understand the concept better.

Source

In the above chart, the red dotted horizontal line indicates the resistance level. It shows that at that price level, the selling pressure generated by the bears in the market has been strong enough to resist the buying pressure, resulting in a drop in price. Once a breakout above this horizontal line materializes, individuals can enter a long position to benefit from the rally. If individuals want to see more charts to get a clear idea of this concept, they can visit the TradingView website.

Resistance vs Support

The differences are as follows:

Resistance: It is a price level in asset trading where the selling pressure is expected to be stronger than the buying pressure, leading to a potential pause or reversal in an asset's upward price movement. It acts as a barrier that traders consider a point of overvaluation. It stimulates them to sell their positions. Investors may sell or short-sell an asset near these levels as they predict increased selling activity and a potential price reversal.
Support: This is a price level in trading where the buying pressure is expected to be stronger than the selling pressure, resulting in a potential pause or reversal in an asset's downward price movement. It is a level in the asset price that traders view as a point of undervaluation and encourages them to buy the asset. Traders may buy or enter long positions near support levels, anticipating increased buying activity and a potential price reversal.

Frequently Asked Questions (FAQs)

1. What causes resistance in trading?

It occurs primarily because market participants consider an asset overvalued at a certain price level. When the price approaches this level, traders start selling their positions, creating a supply-demand imbalance. This selling pressure restricts further price increases and leads to a pause or reversal in the asset's upward movement, leading to the formation of these levels.

2. What is the significance of resistance levels?

These levels are significant in trading because they represent price zones where traders perceive an asset as overvalued. These levels act as psychological and technical barriers that can limit further upward price movement. Traders pay attention to these levels as they indicate potential selling pressure and market hesitation.

3. Are resistance levels always reliable?

These levels are not always reliable, and investors should not make decisions solely based on these levels. While they can offer valuable insights into market behavior, they are not guaranteed to hold or prevent further asset price rises. Market conditions, investor sentiment, and other factors can impact the effectiveness of these levels. Traders may use more technical analysis tools and risk management strategies to enhance their trading decision's reliability and avoid relying only on these levels for accurate market movement predictions.