Chapter 12: What are Supports & Resistances? (Part 1)

Chapter 12 - What are Supports & Resistances (Part I)?

In our earlier chapters, we have learnt and understood the concept of Candlesticks (Single and Multi) and their application in our day-to-day trading decisions. We also got acquainted with the entry points for trade and to an extent, we also understood the mechanism of spotting stop losses for the trade. Learning candlesticks also gave us a sense of understanding the psychology of day traders. But, we are yet to discuss the third most important facet of any trade i.e., determining the exit point (or targets) for the trade. And finding the right points of exit is of utmost priority for any trade to be successfully completed.

The best way to determine the profit point for the trade is to understand the support and resistance (S&R) for the trade. For long (buy) trades, the levels of resistances can be taken as target levels. And for short (sell) trades, the support levels can be taken as targets. Through this chapter, we aim to understand the concepts of Supports and Resistances. 

With a thorough understanding of the concept of Supports and Resistances, one can sometimes anticipate reversals in the market and take trades accordingly. 

What are Supports?

The general meaning of the word support is something that provides the impetus. It is something that protects or stops the fall. And in the world of trading and investment, support is understood as the zone of demand. It is a point beyond which, the market finds it difficult to continue with its selling momentum. And supply is expected to be halted and buying is expected to come back in the market. It is also the first level of target for short positions in the market. And if the market breaches these levels of support, then the next level of support comes into the picture.

 

Let us try and understand the concept of support with the help of a few illustrations:

The stock under consideration here is TITAN limited

 

Following are some observations:

  • The market has been constantly supported around Rs. 205 levels and it has given a bounce-back up to the tune of 40-50%. The trade targets are on the higher side as the time frame for this chart formation is on the higher side. The holding period sometimes can last for months, but the risk to reward ratio is very lucrative.
  • 205 can be taken as the first level of target for shorts in the market.
  • As and when the market comes near the support levels, fresh long positions can be initiated and looking at the chart, we can say that the stop loss is a mere 6-8% of the investment value.

So, if one were to initiate longs in the market, then the trade could be initiated with the following specifications:

  • Entry Point - 205-210
  • Stop-loss -195
  • Target - 300

In our next illustration, the stock under consideration is Maruti Ltd.

Now, if you look at the image above, the trendline is formed by joining two or more points. More the points joined to form a line, the higher the conviction in the trade. In the example under consideration, the share price of Maruti limited constantly gets supported as and when the share price comes near the zone of support. And it ends up giving returns to the tune of 3-15% depending on the price action around the levels of support. 

Following are some of the key observations:

  • Unlike in the last chart of TITAN Limited, which had the same levels been tested again and again, and the market bouncing back from there.  In this chart of Maruti ltd, the support is the trend line support.
  • The trendline is formed by joining multiple points (minimum two) which are aligned. If the trendline is formed by the joining point which is continuously forming higher lows, it is called trendline support.  
  • With every passing day, the level of support keeps moving up. And the stop loss for any long trades taken is the meeting point of the candlestick on the trendline on that particular day.
  • And one needs to keep trailing up the stop-loss, to take maximum advantage of the move upside. 

How to identify trades using supports?

The expectation from the trade decides the kind of trade which one can take from one particular kind of support. 

  • If one is looking for short term trades like intraday or BTST (buy today, sell tomorrow), when one looks to take the trade with medium strength support.
  • But, if one is looking for swing trades, then the support for those kinds of trade has to be stronger as these are long duration trades.

Intraday or BTST trades:

These trades are generally short duration (one or two days), and hence the expectation from these trades are on the lower side and which also means that these trades have small stop losses. And one key factor to understand here is that these trade opportunities are more in number than swing or long term trades. 

 

The chart above is a 15 minutes Kotak bank chart. And the support used to identify the trade is the trendline support. The stop loss for this trade is below the trend line and the targets for such trades are the recent highs. And if we carefully look at the chart, there are 6 trading opportunities provided (circled) and all of them have given a return to the tune of 3-10% within a very short span of time. One thing to keep in mind is that we

 should always have a very tight stop loss for the trade because if short time frame supports are not defended, then the next support level becomes an immediate level of target for the prices to fall upto.

Swing Trades:

The major difference between the Intraday and Swing trades is the holding period for the trades. Intraday trades have short holding periods, whereas swing trades have a relatively long holding period (sometimes weeks to months). Another difference lies in the profit potential from the trades. Small targets are the basis for intraday (or BTST) trades, but the targets in the case of swing trades are larger and generally, the next supports or resistances (depending on short or long positions) are the targets for these kinds of trades.

Key Takeaways:

  • By having an idea of Supports and Resistances,  we can have a clear understanding of targets for longs and shorts​
  • Supports help in getting the right entry price for longs in the market​
  • The kind of trades goes a long way in deciding the time frame for supports​
  • Supports if defended gives a very good risk-reward on the trades