Karthik has recently opened a demat and trading account and is raring to go. But he still needs to get a better hold of share market basics and intraday trading. For instance, he has come across terms like resistance and doesn’t know what to make of it.
Thankfully for Karthik, his friend Raghu is quite an expert and can teach him a thing or two about not just how to invest in stock market but also about what terms like resistance in the market mean. The two friends meet up for a chat.
“So, the term resistance should actually give you a sense of what it means in the context of the stock market. At the very simple level, resistance is a term traders use to refer to the price level on charts that stop an asset price from being pushed in a specific direction,” Raghu starts off. Karthik is all ears, as he continues.
“There are usually two terms that are constantly used: support and resistance, but for now, let’s stick to resistance since that’s the first term you were intrigued by. Just so you get a broad idea, support is a term that describes a price level when a downtrend is expected to hit pause. This could happen because of demand getting concentrated or a lot of interest in buying. But let’s get back to resistance.” he explains.
“As definitions go, resistance is the point at which the increase in an asset’s price is stopped owing to a rise in the number of sellers who want to sell at that specific price,” he points out.
“Investors tend to observe where resistance seems to be happening on a stock chart so that they can decide whether it is a good idea to buy the stock at a lesser price or sell it at a point that nears the level of resistance,” he adds.
“I understand but if you could give me an example, it could help me get better at intraday trading and understand share market basics better too,” points out Karthik.
“Sure, so…let’s imagine a stock is trading close to Rs 100 but falls at Rs 90. An investor who lost the chance to sell at Rs 100 will realise that he would have gained by selling it on time. So, he intends to wait and see if the price touches Rs 100 again. So, what happens in this scenario?” asks Raghu. “Hmmm, let me see…there is an increase in pressure to sell,” notes Karthik. “This is how an earlier high can become resistance in the future,” Raghu points out and continues, “If the price touches Rs 100 again, there is one more set of people who will realise that they would have been better off had they bought the stock at Rs 90. So, they will then wait for the stock to come down to Rs 90. So, this then turns the earlier bottom in the support points.”
“Thanks much, Raghu, but I have one more question. How do I spot this resistance level?” Karthik asks.
Raghu obliges with his answer. “Ok, so take a daily stock chart and draw a line that connects the recent highs/peaks. This line may look horizontal, sloping down or up but irrespective of that, you can spot how every time a stock neared it, there’s a reversal. It is this point that’s called resistance level.”
Breaking out and reversing
“Can a stock price break through this level,” Karthik wonders aloud. “It is certainly possible that the stock price can break through both resistance and support levels. When such a thing happens, and it does happen often, there are new levels created. If a resistance level gets breached, the price of stock rises till a new resistance level gets formed,” Raghu chips in.
“Also, when the resistance level is broken, its role gets reversed. If the price drops below the support level, that level becomes your resistance, and if the price goes above the resistance level, that can become your support. ” Raghu explains. “If you can get hold of some charts, see how you can spot prior resistance becoming support and vice-versa. That will be a good exercise,” Raghu adds.
“That was so helpful, Raghu. I will put my demat and trading account to good use now having learnt how to invest in stock market. Also, thanks to your clear explanation of terms like resistance, I will hopefully move beyond share market basics and turn pro!”