“Nifty should take a support at 15800!”, “The stock has broken all of its support levels!” & “Where will the Sensex find its support during the fall?” These are the kind of statements which are often said in newspapers & business TV channels. Retail investors and traders hear such news and begin the wonder – How are support levels found by TV experts? How can I use this information to my advantage? Let’s learn about support levels!
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What is support in stock trading?
A support level (or a support zone) is a price of an asset from where the price has historically increased. Simply put, a support is a price in which the asset’s demand increases & buyers are willing to enter, taking the price higher.
Let’s suppose that Reliance Industries has a support at Rs. 2250. It means that the stock price of Reliance Industries has previously bounced higher whenever it reaches Rs. 2250. Buyers think that buying Reliance Industries at Rs. 2250 is a good deal & therefore, the price (generally) doesn’t fall below this level. Please note that a support can be different for the same stock depending on the time frame which you use for your chart study. Reliance Industries might have a support level of Rs. 2250 on a daily chart, however it might have a smaller support of Rs. 2400 on an hourly chart! Generally, the support levels which are reported on the news are taken by using a daily time frame of the stock chart.
How to find support on a chart?
The simplest way to find a support to observe the price-action! Support is found by looking for a price from which the stock has bounced upwards multiple times. The key point here is that the price should have bounced from this level multiple times. The more occurrences which can be found of an increase in price after reaching a certain level, the better the chances are of that price to act as a support! Let’s try to understand support using price-action on a stock chart.
Here, it can be seen that whenever the price of the stock reaches Rs. 2325, it bounces higher! This has happened multiple times on the stock chart. Therefore, if this stock ever falls, it can be expected that this price will act as a support again!
This chart shows another example of a support level of Rs. 1650 working perfectly from which the price has bounced up 3 times eventually leading to the breakout of the stock!
Similarly, the above stock took support at Rs. 280 multiple times before giving a breakout. A support can be found by simply drawing a line at a price level from which the stock has historically bounced up multiple times!
The same procedure has been followed for this last stock chart. It can be seen that the stock bounced up thrice from Rs. 210. Therefore, Rs. 210 can be considered a strong support level for this stock.
The inference which can be drawn from all these charts is that whenever a support level is reached, buyers take up fresh long positions causing the price of the stock to increase. However, this is not the only method using which support can be found! Let’s look at other methods which can be used to find stock support levels.
Can other methods be used to find support?
Yes, there are two more methods which are commonly used to find support for a stock. These methods are – moving average & trendlines. Let’s take an example of both methods to find support for a stock.
Moving average
Moving average is considered to be an important support for any stock. A rising moving average along with a price higher than the moving average shows the bullish nature of a stock.
On the other hand, a falling moving average with a price lower than moving average shows the bearish nature of a stock.
Moving average (typically 50 Simple Moving Average) can act as a support for a stock. Let’s see examples where 50 SMA is acting as a support for a stock.
Here it can be seen that the stock has taken multiple support on the moving average. This method can be a good way to find out the support level of a stock.
Trend line
Trendlines are lines which are drawn to find out a level which the stock price has continuously bounced higher. Trendlines can be drawn by observing a rising or falling pattern which is observed on a stock chart. Here is an example of a stock taking support on a trendline.
Why do support levels work?
Support levels work because every trader is watching these crucial levels on the stock charts. Since most traders expect a bounce in the price from a support, many traders take fresh positions on supports essentially causing the number of buyers to overcome sellers leading to a rise in price.
If most market participants think that ITC stock is available for a fair price at Rs. 200 every time the stock hits this level, it is likely that the participants will think the same if the stock falls to Rs. 200 again!
Do support levels always work?
No! Support does not always work. There is no support level which is impossible to break for the market. Nobody can predict the market and therefore, nobody can predict the exact reversal of the price from a support. To learn more about this, visit – Can anyone predict the stock market?
However, chances of a bounce in price increases significantly when the price comes near a support. Even though there is no guarantee of a bounce, often it is seen that a bounce is observed (even if it is short-lived).
So, Supports are breakable! But when do they work best?
Supports work best during an uptrend!
It is often observed that markets break every resistance one-by-one during an uptrend while respecting the support levels. However, the exact opposite happens during a downtrend. Markets break every support one-by-one during a downtrend while respecting the resistance levels.
Supports should not be considered as a ultimate level to make fresh positions. However, they are high probability levels where fresh positions can be taken up by traders.
How can a trader use support levels?
A trader can use support levels in 2 ways –
- Support level can be used to create a fresh long position. Since the price has previously bounced from a support, it is likely that the price will bounce again from the support.
- Stop Loss can be placed under the support level. This ensures that if the market breaks a support level & proceeds to freefall, the trade is prevented from any major loss.
Conclusion
Support levels are important for stock trading. There are many ways in which support levels can be found out – price-action, moving average and trendlines. These support levels act as a major demand zone and can cause the price to bounce higher. Traders should use these levels to improve their trading accuracy. However, the final decision on trading in the stock market depends entirely upon the reader!
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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