A support is a price level where buyers entered the trade or short sellers covered their shorts with enough force to keep prices from going any lower.
A resistance is a price level where sellers entered the market or old buyers dumped their shares with enough force to keep prices from going any higher.
Support and resistance levels are very important reference points because so many traders recognize them and believe in their significance. It’s herd mentality 101. If enough traders believe in the significance of a support level, traders will not buy until the price reaches that support level. In addition, short sellers won’t cover until that level. Why would they, when they can buy or cover at lower prices?
Similarly, if all traders know there is a resistance level nearby, they will start selling at that level because they are afraid the price might bounce back before they can sell for a profit. Short sellers will also start selling at the resistance level in the hope of a price drop.
It is at these levels that the balance of power between the buyers and the sellers will usually shift. For example, if the buyers are aggressively bidding up and causing prices to rise, and all of a sudden many traders are willing to aggressively sell for less than the last price, thereby causing an immediate price reversal, the price level at which the market stopped is now a resistance level. It really doesn't matter why the balance of power shifted from the buyers to the sellers. There could be all sorts of reasons behind what caused the price to reverse. What is really important is that traders will remember that the market reversed at that particular price level. As a result, moving forward, that price will have a degree of significance in the minds of traders.
If the market reversed very strongly the last time that prices approached this level, there will be many traders who will think it will probably reverse again and they may very well act based on this belief.
In this book, I will teach you how to identify support and resistance on candlestick charts. Once support and resistance are established and identified, they can be very helpful for your trading plan during the market hours.
You may have heard that old support becomes resistance and old resistance becomes support. This market insight is valid, but do remember that when you identify a level on your chart, depending upon which direction the price is approaching it, it can act as either a support or resistance.