Karthik recently opened a trading and demat account. He is eager to get started. He still needs to learn intraday trading and share market basics. He has, for example, come across resistance terms and isn't sure what to do with them.
Karthik's friend Raghu, who is an expert in the stock market, can help him learn a lot about how to invest and what terms like resistance mean. They meet up to have a conversation.
The stock market context should give you an idea of what resistance means. Raghu begins by saying that resistance is a term that traders use to describe the price level on charts which stops an asset price being pushed in one direction. As he continues, Karthik is fully engaged.
There are two terms that are used constantly: resistance and support. But, for now, we'll stick with resistance because that was the first term that drew our attention. To give you an idea of what support means, it is the price at which a downtrend will be stopped. This could be due to a concentration of demand or high levels of interest in purchasing. He explains, "But let's not forget about resistance."
He explains that resistance refers to the point at which an asset's value is stopped by an increase in the number sellers willing to sell at that price.
He adds that investors tend to look for resistance on stock charts to determine whether they should buy or sell the stock at a lower price.
Karthik says, "I get it but if you could give an example, it would help me improve intraday trade and understand the basics of share market basics better."
Let's say a stock trades at Rs 100, but drops to Rs 90. A seller who loses the opportunity to sell at Rs 100 will realize that he would have made more if he had sold it sooner. He will wait to see if the price reaches Rs 100. Raghu asks, "So, what happens in that scenario?" Karthik says, "Hmmmm, let's see...there is an increased pressure to sell." Raghu explains, "This is how an older high can become resistance later in the future." Raghu continues, "If it touches Rs 100 again there is one set of people who will realize that they would have been happier if they had bought the stock at Rs 90." They will wait for the stock price to fall to Rs 90. This will then turn the earlier bottom in support points.
"Thank you Raghu. But, I have a question. Karthik wants to know how to spot resistance levels.
Raghu agrees to his answer. Okay, now take a daily stock chart. Draw a line connecting the most recent highs/peaks. The line can look either horizontal or sloping up, but regardless of whether it looks horizontal, this line will show you how stocks revert every time they get close to it. This is the resistance level.
Karthik asks, "Can a stock market break through this level?" It is possible for the stock price to break through both resistance levels and support levels. There are always new levels when such an event occurs, and it happens often. Raghu says that if a resistance level is breached, stock prices rise until a new level is formed.
"If the resistance level is broken it becomes its reverse. If the price falls below the support level, it becomes your resistance. However, if the price rises above the resistance level then that level can become your support. " Raghu explains. "If you have some charts, you can see if you can spot previous resistance becoming support or vice versa. Raghu says that this will be a great exercise.
Raghu, that was so helpful. After learning how to invest in the stock market, I will now put my trading and demat account to good use. Your clear explanations of terms such as resistance helped me to move beyond the basics of share market investing and become a pro.