Resistance, or a resistance level, is the price at which the price of an asset meets pressure on its way up by the emergence of a growing nu...
Depending on price action, this line can be flat or slanted. There are, however, more advanced ways to identify resistance incorporating bands, trendlines and moving averages.
What Do Resistance Levels Tell You?
Resistance levels and support levels are two of the most important concepts in technical analysis of stock prices. Technical analysis is a method of analyzing stocks that assumes the vast majority of available information about a stock, bond, commodity, or currency is almost instantaneously incorporated in the price by market forces. Therefore, according to this theory, it isn’t profitable to make investment decisions based on this information. Instead, technical traders try to divine how stocks will move on a short-term basis by looking at the behavior of markets in similar, past situations.
Technical traders identify both the resistance and support level so that they can time their buying and selling of a stock to capitalize on any breakouts or trend reversals. In addition to identifying entry and exit points, resistance can be used as a risk management tool. Traders can set stop-loss orders to follow the resistance level or use any breach as a trade trigger. The simply resistance level has to be redrawn as new price data comes but most platforms offer visualizations of resistance that can be dynamically calculated. Moreover, many technical indicators become proxies for resistance at different points of price action. For example, a simple moving average can be used as a visualization of resistance when the price action is below the line as in a downtrend.
Example of How to Use Resistance Level
Let’s say that you are studying the price history of the price of shares in the Montreal Trucking Company, with the ticker symbol MTC, and want to determine a time when it would be smartest to sell the company short. Over the past twelve months, the stock has traded between $7 and $15 per share. During the second month of the period you’re studying MTC, the stock climbs to $15, but by month 4 it has fallen to $7. By month 7, it climbs again to $15, before falling to $10 in month 9. By month 11 it climbs once again to $15 and over the next 30 days it fall to $13 before climbing again to $15.
At this point, you have clearly established a resistance level of $15. If you see no reason for the stock to breakout of the band it has been trading in over the past year, this would be a good time to sell the stock short, because the market has clearly shown that once MTC stock reaches $15, an overwhelming amount of supply comes on the market to halt its further rise. One should be careful, however, as sometimes resistance levels are breached and left behind if fundamental drivers of a stock, like a booming economy or new efficiencies in a company’s business model, overwhelm technical forces.
The Difference Between Resistance Level and Support Level
Support and resistance are complementary concepts. Resistance establishes the current price ceiling for the stock, commodity or currency, and support forms the floor. When the price action breaches either support or resistance, it is considered to be a trading opportunity.
Limitations of Using Resistance
Resistance is more of a market concept than a true technical indicator. As mentioned, there are far finer technical analysis tools that incorporate the concept of resistance while being far more dynamic and informative than drawing a resistance line across recent highs. These include trendlines, price by volume (PBV) charts and the whole swath of moving averages that can be tweaked by time periods to offer a spectrum for resistance levels.
