The Hindu Business Line : Trader's Corner

The first tenet of technical analysis is that price patterns repeat themselves. The reason why stock price movements display recurring patterns is because stock markets worldwide are driven by men.

The basic needs and emotions of men have not changed from primitive times. There is no way we can do without food or sleep. Similarly, human emotions like love, greed, exuberance, depression, contentment, etc., will stay no matter how rapidly technology changes. Human behaviour, exposed to certain set of circumstances can be fairly constant and predictable.

Many of the tools of technical analysis are based on this psychological basis. The twin tools of supports and resistances are one such example. Supports are nothing but troughs (reaction lows) from where a downward movement can reverse. The sellers turn tentative at these levels and the buyers have the chance to wrest the advantage here. The reverse is true with resistance, which are previous peaks. The buyers get edgy at these levels and sellers gain more power.

How do these support and resistance levels work? Well, these are important points of reversal in the past. Every time the price nears these levels, the memories of investors go clickety-clack. They say to themselves, "hey, the price turned from here once so it can very well do so again". That is how these levels prove to be so effective. The human element!

The supports and resistances discussed above pertain to the highest price on a day when a major peak is formed or the lowest price on a day when a significant trough is formed. Other ways in which supports and resistances are derived are with the aid of trend lines, trend channels, Fibonacci retracement levels, moving average lines etc.

If a stock has reversed from a certain price more than once in the past such supports and resistances gain greater credibility. Once a support level has been effectively breached, it turns in to a resistance level for future upward movements. Similarly resistance levels, once crossed emphatically turn in to supports for future downward movements.

Lokeshwarri S.K.

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