What it means
Technical analysis is the study of price charts to judge where a market may go next. A support level is typically found by looking for a price where an asset has bounced several times before.
The idea is that buyers remember attractive prices and tend to return to them. Supply and demand explain why this may happen.
At a lower price, the asset looks cheaper to buyers, so demand increases, and sellers may be less willing to sell at that price. When these forces balance, the price stops falling, at least for a while.
Support levels can be round numbers, previous lows, moving averages or levels from past trading ranges. Traders pay attention to how often the level has held and how much trading took place there.
A level that has been tested several times is thought to be more significant, though each new test also risks wearing it out. When support fails, analysts often say the price has broken down.
A former support level may then become resistance, a ceiling that the price struggles to rise above, because those who bought at that level may sell when they can get their money back. Support and resistance are therefore two sides of the same idea.
The nuance is that support is a probability, not a guarantee. Levels depend on judgement, different traders draw them in different places, and news can overwhelm a technical level in minutes.
Sensible users treat it as one input among several, together with the fundamentals of the business and a firm plan for managing risk.
In practice
Real-world examples.
Example
A currency trader notices that a pair has stopped falling at the same level three times in six months. She buys near that level, planning to sell if the price drops below it. The plan limits her loss to a small, known amount if the pattern fails.
Example
An equity analyst writes that a retailer's shares have strong support at $30, where the stock traded for months before its last rally. A client uses this information to decide where to place a limit order. The client sets the order slightly above $30, because the level may not hold exactly.
Example
A commodity producer watches oil prices approach a well-known support level. Its treasury team considers whether to lock in a hedge before the price breaks down further, which would reduce its revenue. The team agrees to hedge half of expected output now and review the rest if the level fails.
Formula
Calculation
Risk-reward ratio = (target price - entry price) / (entry price - stop-loss price)
Suppose a share has bounced off $50 three times, so a trader sees $50 as support. She buys at $52, sets a stop-loss just below support at $49, and sets a target of $58. The risk per share is 52 - 49 = $3, and the reward per share is 58 - 52 = $6. The risk-reward ratio is 6 / 3 = 2, meaning she stands to gain $2 for every $1 she risks. If she buys 1,000 shares, her maximum planned loss is 1,000 x 3 = $3,000 and her target gain is 1,000 x 6 = $6,000.Case study
Seen in the real world.
Harrowgate Energy Partners is an illustrative, fictional company whose treasury team hedges its fuel purchases. The treasury analyst noticed that the price of a key fuel had fallen to $70 a barrel, a level at which it had stopped declining twice in the previous year.
The team decided to buy a portion of its next quarter's fuel there, 40% of expected needs, which was 200,000 barrels. They kept the remainder unhedged, so that the company would benefit if prices continued down. The treasurer wrote the reasoning into the hedging policy file so the board could review it later.
When the price later broke below $70 and fell to $62, the unhedged portion saved money while the hedged portion cost an extra $8 a barrel. In this illustrative story, the treasurer concluded that support levels were useful for timing but should never be relied on for the whole position.
Watch out
Common mistakes.
- Treating support as a guaranteed floor, when it is only a level where buying interest has appeared before.
- Ignoring news and fundamentals, which can push a price through support in a matter of minutes.
- Buying without a stop-loss, so that a failure of support turns a small, planned loss into a large one.
Questions
People also ask.
What happens when support breaks?
The price often falls further, and the old support level may turn into resistance, which is a ceiling above the price.
How do traders find support?
They look for previous lows, repeated bounces, round numbers and moving averages, and then judge how often the level has held.
Is support useful outside shares?
Yes, the idea is applied to currencies, commodities, bonds and indices, though the same cautions apply to each.
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