Have you ever seen analysts and traders obsessing over price charts, studying all sorts of lines? As it turns out, some of these plain old lines are actually quite insightful and help the market make more informed decisions. In the realm of the financial markets, the stock resistance level is an important indicator that market players use to guide their buying or selling decisions. Through this many can optimally time their entry and exits from positions.
In many cases, the knowledge of the stock resistance level determines whether or not a trader’s move has been profitable. This is because this technical indicator is a great predictor of price movement, helping traders move accordingly.
Overall, resistance levels are incredibly helpful markers that financial players often consult. We shed light on this important tool to help you make more informed decisions, armed with better information on price trends in the market.
What are stock resistance levels?
A stock resistance level is simply a point beyond which a particular price is unable to move beyond. Just as its name implies, there is a high degree of resistance in the market which obstructs the security from surpassing the given price.
To those watching the markets, it is extremely useful to know which are the levels beyond which stocks are unable to overcome resistance. When they do manage to break through, the reaction from the market is usually extraordinary.
These levels of resistance are also useful for everyday trading situations. For instance, if a stock has risen substantially, and cannot progress beyond a certain point, it may be a good time to sell it off, with little chance of further gains.
Similarly, when a stock does break through a point of resistance, market bulls would typically rush it, to ride the growth wave. They would likely do so until a new resistance level is made clear.
How to Use stock resistance level?
Investors can use chart patterns and technical analyses to identify levels of resistance relating to particular stocks in the market. By assessing historical trends on patterns, traders may pick out consistent points of resistance.
Once market players are certain of which levels a stock’s price can not normally climb beyond, they could use this information to their advantage in the following ways:
When a certain stock approaches its level of resistance, it may reverse its growing trend, so selling it at that point may be a prudent move.
If a stock does manage to break past its resistance level, traders may likely hold on to it to capture additional growth, until a new resistance point is shown.
Through this simple, yet highly effective approach, market participants could optimize their trading performance. By using stock resistance levels, they would effectively know the limits of the gains they aim for.
Example of stock resistance level
Now that we have a basic idea of what the level of stock price resistance actually represents, we can dive right into a real-world example, and examine its application for traders.
We take a look at the Chinese e-commerce king, Alibaba Group Holding (NYSE: BABA), over the last 12 months:
As can be seen in the price trend above, the $122 point has consistently acted as the limit to BABA’s growth in the last 12 months. It is evident that the market simply does not let its pricing get beyond $122.
The stock hit its 12-month high in July at the resistance point, but what followed was a crashing fall. Similarly, it had risen to a similar level in early 2023, only to have hit a ceiling, sending it back down to double-digit prices.
Those that identified this level of resistance had potentially saved themselves from serious capital loss, having sold BABA close to its highs. Others holding on to it know when they may continue on their long position.
The Difference Between Resistance Level and Support Level
Another concept that goes hand in hand with price resistance is that of support levels. A support level is the flip side of a resistance level, as it establishes a floor, beneath which a stock usually never falls to.
Since both are barriers, resistance prices show decreases in demand and increases in supply, whereas support levels show increases in demand and decrease in supply.
Similarly, resistance and support levels together are good indicators of market sentiment. They show the points where the market considers a stock to be over and undervalued, respectively.
In fact, with the shift in market sentiment, a support level can become a level of resistance, and a level of resistance can transform into a support level. Below are examples of each:
Resistance Level becoming Support Level
Often when new information enters the market, and fundamentals show improved growth potential previous resistance prices do not seem so overvalued, and demand begins to increase at those levels.
When this happens, prior resistance points end up forming a new support baseline, translating to an upward surge in the price. This is demonstrated in the example below:
Support Level becoming Resistance Level
Similarly, as market sentiment shifts, it is also likely that a prior support level can end up acting as a new resistance point for a particular stock trading in the market. This comes about due to shifting trends.
With the market taking on a more pessimistic stance, the support level seems to overprice the stock, which causes it to plunge, and not rise beyond the previous support level, which now becomes a resistance point.
Limitations of stock resistance level
While using resistance lines offers a great degree of utility and assistance to market traders, it is important to keep in mind the limitations that are inherent to these tools. These are listed below as follows:
Resistance prices should not be assumed to be set in stone, as these shifts rapidly and quite unpredictably. Trading strategies must regularly be updated based on new market dynamics, without reliance on outdated assumptions.
Relying solely on resistance and support lines is a dangerous approach, as it is important to make an investment decision based on a complete picture. Company fundamentals, macro conditions, and sentiment should all be considered.
With respect to certain stocks, resistance points may not be a relevant factor. This is especially when patterns and technical bearings have no significance, in volatile markets, or after major news events.
Levels of resistance are not objective calculations and are usually interpreted subjectively. For this reason, different players may disagree on where these lines are seen, if at all. This leads to confusing signals and uncertainty.
Psychology of support and resistance
The concept of support and resistance, although does not necessarily have a bearing on a stock’s fundamentals, it very much relates to the mindset of market participants. In fact, support and resistance both boil down to psychology.
Stock resistance levels come into formation when buyers and sellers collectively agree that a certain price is too high for a particular stock to be trading at. It is essentially an overvaluation by mindset.
The same is true for support levels. These shared beliefs about a stock’s adequate valuation impact buying and selling, which establishes precise supply and demand dynamics. These then go on to set trend lines as resistance and support.
The psychology of traders is what directly sets these lines. For this reason, these can be great tools for gauging market sentiment. It is important to remain aware of the limitations of human psychology. Some of these pitfalls are as follows:
When market players overestimate their trading strategies, leading them to take on unjustifiable risks.
Fear and greed can cause traders to act impulsively.
Following the behavior of the wider market without your own investigation.
Ignoring information that contradicts your viewpoints.
Not accepting a loss, and holding on to that position indefinitely.
Factors that Influence Resistance Levels
There is a range of factors that go on to influence the levels of resistance seen across the market. Understanding these could help traders predict the behavior of these barriers, and when breakthroughs will occur. These factors are:
Demand and Supply
At its most fundamental level levels of resistance form due to demand and supply dynamics. At prices where supply outweighs demand, resistance forms, whereas the opposite case gives rise to support levels.
While demand and supply may be the most fundamental factor, it is driven by traders’ mindset and sentiment. Due to psychological reasons, players overbuy and oversell stocks within a precise range, which forms levels.
Wider macroeconomic indicators also influence which price points show resistance.
When GDP growth is high, inflation is moderate, and employment data is positive, demand for financial securities are typically high. This raises the levels of resistance significantly.
When positive updates appear in the market, about the prospects of a company, its stock resistance level undertakes quite the climb. In this case, the previous resistance becomes the new support level.
Stock resistance levels are incredibly useful measures that traders often use in their analysis. They point out the barriers to a price trend beyond which stocks are supposedly unable to climb beyond.
These levels of resistance are caused by demand and supply dynamics, which are directly driven by trader psychology at a collective level.
There are several factors that cause resistance to form at certain price levels. Understanding these factors can help market players to predict the formation and behavior of these levels of resistance.
It is important to note, however, that relying solely upon resistance and support levels to guide trading is seriously risky. For the best trading strategy, a holistic approach must be taken, while considering in all relevant factors.
What if a stock price breaks through a resistance level from below?
If a stock price breaks through a resistance level from below, there is an indication of a bullish signal, caused by a surge in demand for the stock. This typically means a major price rise is imminent.
How to find the resistance level of a stock trending upwards?
To identify the level of resistance for an upward-trending stock, one would need to look at the historical price chart for the stock. Through this, previous highs can be studied, and upward barriers can be pointed out.
What is strong resistance in the stock market?
In the stock market, strong resistance is a situation where the supply for a stock heavily outweighs its current demand. This may be due to a large number of short-sellers betting against the stock.