Resistance in technical analysis is a price level that a rising stock can’t seem to overcome. Once a stock reaches its resistance level, it often stalls and reverses. Resistance is caused by heavy selling that overpowers buying, and typically occurs at specific resistance price levels.
Resistance in the stock market refers to a phenomenon where selling at a certain price level prevents a stock from exceeding that price. Investors sometimes observe where resistance seems to be taking place to decide whether it's worth buying the stock at a lower price or selling near the resistance point.
Spotting a Resistance Level
Draw a line on a daily stock chart connecting two or more recent peaks. The line may come out up-sloping, down-sloping or horizontal, but regardless of the angle, you'll see how each time a stock approached it, it reversed.
That point is called a resistance level in technical analysis, which is a way of evaluating stock prices that focuses more on observing trends in pricing than on fundamentals of the company itself.
Stock Support and Resistance
If you connect two or more recent price lows, you'll obtain another important trend line called support; each time a stock reached it, it stopped declining and reversed. When a stock declines, it may form several levels of support in which its price stabilizes and bargain hunters start buying on the assumption that the stock has reached bottom, but the stock may break through support and continue lower.
Investors who bought at support vow to sell as soon as they break even – that is, when the declining stock comes back up to the former support level at which they bought it. At some point, the stock stops declining and turns back up. Each time it reaches a former support level, these bargain hunters start selling. Their selling stymies the advance – former support becomes new resistance. The more shares were purchased at an old support level, the stronger the new resistance will be.
Support and resistance are similar phenomena, with one capping price growth through selling and the other stopping price drops through bargain-seeking buying. Of course, both are not permanent phenomena, and stock prices ultimately can move past support and resistance levels.
Understanding Investor Psychology
Traders who understand human psychology in the market start taking profits as soon as a stock reaches a former support level. But resistance is harder to explain when a stock is making new highs in the absence of support to form a new resistance barrier.
Every stock fluctuates with different amplitude: some advance in tight patterns, others make wide and lose swings, but they all stop at the resistance line. The reason may be purely psychological: Other traders draw exactly the same lines and start selling at exactly the same levels, so resistance becomes a self-fulfilling prophecy.
Nowadays, some trading is also automated, but similar algorithms used across multiple trading organizations can have a similar effect to human psychology.
Establishing Price Targets
Some investors set price targets based on profit objectives. For example, a fund may decide to sell a stock when it’s up 20 percent or when it reaches a specific price. If enough investors decide to sell at the same price level, their collective selling will cause resistance. Similarly, if enough investors decide to buy once a stock has fallen a certain amount, those transactions can naturally lead to price support.
Analysts and financial advisors sometimes share or publicize price targets for a stock based on factors like expected earnings, the potential for future dividends and comparisons to other stocks in the same industry. These can naturally influence investor behavior and help to establish support and resistance levels in the shifting stock price.
Based in San Diego, Slav Fedorov started writing for online publications in 2007, specializing in stock trading. He has worked in financial services for more than 20 years, serving as a banker, financial planner and stockbroker. Now working as a professional trader, Fedorov is also the founder of a stock-picking company.