Help me understand concepts of support and resistance levels to analyse stocks.


Help me understand concepts of support and resistance levels to analyse stocks.

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Suppose the current price of Ephemeral Inc shares is 15 magic beans, but that there are a huge number of people out there who would like to buy those shares for 10 magic beans. If the price ever dips slightly below 10 magic beans, those people will all start buying, helping to keep the price from ever going significantly under 10. This is called “support” – there is “support” for Ephemeral Inc shares at 10 magic beans.

Similarly, suppose there are loads of people who would like to sell their Ephemeral Inc shares for 20 magic beans. If the price ever climbs that high, those people will all start selling, stopping it from going significantly above 20. This is “resistance”.

Some people think that you can look at a price chart and divine where the support and resistance are. For example, maybe a share has fallen to roughly the same price several times but has never gone below it – maybe this is because there is strong support at that price. Or maybe it’s purely a coincidence. Or maybe there *was* support but it’s now gone away. Or maybe it’s because a bunch of traders think there must be support at that level and think that the price will never go below it, creating a self-fulfilling prophecy.

As for why there might be support or resistance – there can be a lot of factors. Maybe there is some big institutional investor that owns a huge number of Ephemeral Inc shares and has some specific reason why they would want to sell them off at 20. Maybe it’s a psychological thing where 20 seems really expensive, like how retailers set prices at 9.99 because it feels significantly cheaper than 10.00. Maybe it’s a self-fulfilling prophecy thing, like I mentioned above.

Anyway, if you’re getting into financial trading, please bear in mind that it’s essentially gambling, but that you’re often gambling against people who have insider information, or who have fancy complicated models that you could never hope to rival, or who have so much money that they are able to manipulate market prices single-handedly.

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A lot of it has to do with self-fulfilling prophecies. If it is widely believed that a stock’s support level based on traditional charting techniques is at a certain level, trader’s will often position themselves based upon this. For instance if a stock has a support level at $200, you may have a proliferation of buy orders get triggered when the stock hit’s $200. This creates incremental demand and pushes the stock up off the $200 level.