What Is Resistance ?
Resistance is one of the foundational elements of technical analysis (along with its corollary--support). Resistance is a price or price zone above the current market that contains the upside movement of an asset. Resistance is where selling interest appears over time, blocking further upside progress.
Resistance can be a single price point, such as the high of the day, or hourly high. Resistance can also be a zone, meaning an area several points wide, such as $0.50/$1.00. A resistance zone represents a test of the resistance level, which may be broken by a small amount, but ultimately turns back the price advance, leaving the resistance level essentially intact. It could also be interpreted to mean that there is even more supply around the resistance zone, potentially signaling a reversal lower.
Resistance can be found in any time frame of chart analysis, where a longer timeframe (daily or weekly) suggests a more important, multi-day resistance level, while a short-term chart (hourly, 30 minutes) may reveal only minor resistance (good for day-traders) .
- A resistance level represents a price point or price zone that an asset has had trouble breaking above in the time period being considered.
- A resistance level may be several points wide, due to multiple attempts to break above the resistance, potentially forming a resistance zone and sending prices lower.
- Trendline analysis is a simple but powerful way to identify areas of resistance; while other mathematical methods are frequently used as well.
- Resistance levels are important to identify for multiple reasons: where to place a stop for a short position; where to place a take profit order for a long position, and when to enter a long position on a break of resistance (a breakout trade).
How does Supply and Demand Affect Resistance?
Demand for an asset is what propels it higher over time, absorbing market supply along the way. Liquidity refers to the amount of total supply and demand at any given time. High liquidity is likely to limit the overall share price movement, while low liquidity may see prices move excessively, potentially making a gap. The source of the demand may be a piece of macroeconomic news, such as a comment from a Fed official or an earnings release. After a series of gains, however, the demand may eventually lessen or stop altogether, as in the 'buying spree has ended,' If the price forms a top, it now functions as a point or zone of resistance.
Supply can come from multiple sources, such as take-profit selling around a resistance point or zone. Another example is where option holders may want to defend their option positions by selling a lot of shares at a specific price point ahead of resistance. And of course, macro news may pull traders in to short the market for a specific stock or other asset if negative news emerges, leaving a resistance point behind in its wake.
Resistance is Made to be Broken
Using technical analysis, traders can identify a particular point or zone of resistance. That resistance zone is likely to be tested in the midst of an uptrend. If the trend and buying interest are sufficient to challenge a resistance point, traders may find that the resistance area breaks, bringing in yet more breakout buyers. Stop loss buy orders above the resistance area may also come in to play, bringing in yet another source of buying, and clearly breaking above the resistance.
After a resistance point has been overcome, it is not unusual to see sellers briefly test lower to the breakpoint to see if it holds. If it does, then traders are likely to conclude that the break of resistance is valid and that the upside is in play. This is an example of a broken resistance level turning into support. Known as the Polarity Principle, once resistance is broken, it becomes support, and vice versa. Whether it is now major or minor support depends on the time frame of the resistance. A break above a recent daily high is more bullish than a break of an hourly resistance point.
Trading Using Resistance
Once identified as a point of resistance, agile traders may seek to sell short on the approach to a particular resistance point, say $105/share, or take profit on existing longs at or near to $105, both fresh sources of supply potentially reinforcing the resistance point. For traders who went short ahead of the resistance on speculation will be looking to buy back once the anticipated down move looks like it is about to end, or does ends.
If the price moves higher to test the resistance point, those take-profit sell orders may get filled, reducing one source of supply. If speculative short-sellers also get their orders filled, another source of supply is now gone. Most likely, the short-sellers probably have left stop loss buy orders higher above the resistance point or zone, allowing a margin of error for slippage. Should the uptrend continue and eventually break above the resistance level, those stop loss buy orders may get triggered, generating a new source of demand that pushes the price higher. Alert breakout traders may enter the market on the buy side, adding another source of buying demand.
Identifying Resistance Levels with Trendlines
Trendlines are powerful tools to analyze a security's historical price action and identify resistance levels. The chart below shows an hourly view of NVDA. Note how an hourly top is formed at 220.00/50, and is subsequently broken, leading to gains in the price to 230.00/50, which is tested again and holds, forming a double top in the process. Also, note that 220.00/50 later becomes a pivot line, acting both as support and resistance on multiple occasions, respecting the notion of polarity, that broken resistance becomes support and vice versa.
In the daily NVDA chart below, we can see how trendlines and basic pattern recognition can provide significant price signals and trading opportunities. On the left side, a double top pattern is formed over several days, suggesting a top and opens up downside potential. The following lows create a horizontal trendline which holds after price failed again at the $190/share level. The price eventually tests the $140/share trendline level which holds, and price goes into a strong upward channel, breaking above the $190 major resistance and extends to the $230/share level, where another double top is formed suggesting the uptrend is over for the time being.
Alert readers may have noticed that the resistance levels encountered above are key, big-round numbers like 140, 190 and 230. These are frequently referred to as psychological 'big figures,' meaning traders pay close attention to these levels as potential zones of support and resistance. There may be no good reason to pay attention to them on their own, but psychological behavior make them potential resistance levels.
Identifying Resistance Levels with Trading Systems
There are many different technical tools that can be used to identify likely resistance levels based on mathematical formulas. Among them are simple and exponential moving averages (20,50,100 are favorites), Ichimoku or Cloud charts, and Bollinger Bands, to name a few.
Below we have an example of a daily NVDA chart with Bollinger Bands overlaid. Bollinger bands are a momentum indicator set at 2 standard deviations from a simple 20 day moving average in the center. As you can see the upper Bollinger band neatly contains the price advances over the course of weeks, giving traders an up-to-date upper resistance band. That level could be used to take profit on long positions, while the moving average in the middle identifies the overall trend.
What is Resistance?
Resistance is a price point or price zone that acts to limit gains in a security due to greater supply than demand.
How do I Identify Resistance Levels
Resistance levels can be identified through technical analysis of charts and the various tools that come with them. Among the favorite tools used to identify resistance levels are key highs, trendlines, moving averages (simple and exponential), Bollinger bands, and Ichimoku or Cloud charts.
How do I trade with resistance levels?
It depends on your position and view of the market, as resistance will eventually be broken at some point. An aggressive trader might go short from just below the resistance level, looking for a pullback or reversal lower, essentially speculating that the resistance will hold. That same trader would also likely place a stop buy order above the resistance zone in case it breaks . A breakout trader might jump in on the long side if the resistance area is breached. A trader who is long might want to place a take profit order to sell near to the resistance zone.
What is the Polarity Principle?
The Polarity Principle refers to the price phenomenon whereby once resistance is broken, it becomes support and vice versa. A break of a resistance zone will usually see a quick test of the breakout level to see if the break holds, or if it fails and reverses lower.
The Bottom Line
A resistance point or zone develops when prices are unable to move higher from that zone. Resistance levels can be found on short-term or long-term charts, with long-term resistance levels carrying more weight for the overall direction of the next move in the security. Resistance levels are identified by technical analysis or visual inspection, using such tools as trendlines, horizontal lines, moving averages, and Bollinger Bands.
From a trading perspective, resistance levels offer various trading opportunities. You may go with the flow and buy into a resistance zone, looking for a break higher, you might jump in on the long side after a breakout has occurred, or you could look to sell into the resistance zone, going short, holding the view that the resistance will hold and prices will turn lower. No matter your situation, once prices near a resistance zone, it's time to take notice of the price action and subsequent opportunities.