Support and resistance explained for beginners | Price action and the human behavior behind them

Let's start!

Hello Everyone! In this video, I will be sharing the logic behind the price action that forms support and resistant in the stock market. By understanding the price action behind, we can then understand how to apply support and resistant in our analysis.

I am going to start with a story to understand the price action for both support and resistant, please follow me closely!

Lets start the story.

You come from a village that can craft very unique, special and beautiful ring. One day, you have decided to venture a new business in a new town, located around 100 km away from your village. You bought and collected 100 rings from your villages at a price of $90.

Then, you set up a stall in the town. Your selling price of the ring is $100. Out of your expectation, you manage to sell 50 rings within 1 day! Because of the high demand, you have decided to increase the selling price to $120. You still manage to sell 30 of them! For the last 20 rings, let's sell at $150! Guess what, you managed to sell everything. With the nice profit on hand, you have decided to go back to your village to buy more rings. This time, you decided to buy and collect 500 rings, and go back to the town again.

This round, you straight away put the selling price at $150. One customer, Mark, came and bought 250 pieces from you. Because Mark bought at a large quantity, you have decided to sell him at a price of $120. You are very happy and decided to further raise the selling price to $200. Initially, you still managed to sell 10-20 rings. However, then, you found that no more demand and you did not sell single ring for the next 3 days. You decide to find out what has happened.

Oh my goodness. You found that Mark, also set up a store and sell the same rings at a price of $180! No wonder no one is coming to get the ring from you. Thus, you have decided to cut the price of the ring to $150 to compete with Mark. Mark also did the same, and further cutting the price to $120. Those who missed the price at $120, are rushing in to buy the ring at this price. They think that this is a very attractive price! In addition, as Mark's cost is $120, he does not want to further lower the price. You do not want to further lower the price too, as the demand is still there. This is where demand and supply meet the balance= $120. This is how a support formed as many buyers, are willing to buy at this level; and sellers, are not willing to sell their rings below this price.

Interestingly, one day, a group of businessmen and their family members, who are on a business trip to capital, passing by the town. They love the rings a lot, and willing to buy as many as they can. You and Mark ride this opportunity to sell the rings at $200, $250 or even $300. Seems that the businessmen just buy and do not care about the price. As there are more businessmen group are passing by, other town residents also see this as a great opportunity and go to your village to buy more rings. Because of surge of the demand, the villagers also increase the selling price to $200. At the highest point, the businessmen bought the ring at $350 and they are not willing to raise the price anymore. As the businessmen are the richest group in the town, this is the price celling or the demand ceiling. This level acts like a “resistance" in price level.

After all the businessmen left, the demands reduced significantly. Those bought the rings at higher price are feeling worried and cut the selling price just to sell it. The price then reduced from $300 to $250 and to $200. Here, it stops the price further decline for a while, as many residents bought the ring at $200, and they are not willing to take a loss. However, as the demand is really bad, some of them decided to just sell at $180, and this further caused a panic sell from the others as well, and cascade reaction and further reduced the price to $150, and finally, it back to $120. At this level, the demand is coming back again as the town residents think this is a good level to buy and keep it, which then can be sold at higher price in the future.

A bad news coming. Someone spread a news that the villagers who crafted the rings, use some black magic on the ring that could bring bad fortune to the buyer. This caused a panic sell of the ring, and the supply is much greater than the demand. The price of the ring tanks to $50 at one point! You, as born in the village, you know this is a false news, and decided to buy those rings at $50. Indeed, the rumours is gone and the price back to $120.

Now, let us check the price level of the rings, and analyse what is happening in these levels.

When the ring is at $120, buyers are willing to buy, and the seller is not willing to sell it at lower price again. At this level, buyer > seller, demand > supply, this is a support level.

When the price of the ring is back to $200, those purchase at the lower price, know that this is most likely a ceiling price and will sell at this level. In addition, those who purchased the ring at $200 and even higher previously, will also sell their rings at this level, as they can breakeven or reduce their loss. At this level, seller > buyer, supply > demand, this is a resistance level.

We can also break this scenario in different investing/trading strategy:

As a value investor, you know that the intrinsic value of the ring is around $120. Thus, when the price drops to $50, you know that this is an attractive price to buy in, as the price will finally back to its intrinsic value again.

As momentum trader, the moment it breaks above $200 with high demand (high volume), they will buy high and sell higher. Thus, many momentum players prefer the stock at all time high, as there are less overhead resistance that could limit the price momentum upwards.

As swing traders, they will buy at $120, and sell at $200.

For long term investor, they believe that the demand of the ring will be even higher when the businessmen start to spread the quality and uniqueness of the ring all around the country that will even bring the price of the ring higher. Thus, the long term investor will just hold the ring and buy whenever the price is dipped.

It does not matter which strategy is applied, as long as we can profit from it. Just choose the strategy that gives us the consistent profit and we are comfortable with.

Lastly, when the price will move above the resistance? Using stock market as an example, it can be a good news that shows that more profit can be generated; or the company shows a better than the expected earnings results. This will increase the investor confident to buy the share and create more demand on it. They are also less likely to sell the shares as the future outlook of the company is better. Demand > Supply and the price is going up.

On the other hand, when a bad news is released of the company release a worse than expected financial result, the investor may lack of confident and sell the stocks. Supply > Demand and the price is going down.