Understanding Technical Financial Analysis Terms and Their Importance to Investors: Support Level
Technical analysis is an approach employed by investors to analyze securities based on statistical data arising from the market performance of the stock including prices and volumes.
It is an appliance by the use of which people dealing with securities make appropriate decisions of either selling or purchasing securities.
Among the terms of technical analysis it is necessary to distinguish the action that is called “support level” because it is important for investors to determine the trends in the market, potential for reversal and market activity.
Support level as an essential factor in the trading process, its identification, and significance to investors will be described in this article.
We will further discuss on how different support level can be used in determining the price volatility as well as trading decisions.
What is a Support Level?
The support level in technical analysis is the price level that an asset typically attracts buyers to push up its price and avoid a decline.
Loosely speaking, it is a level at which a given asset, whether a stock, a currency or a commodity, has been seen to trade below.
The levels of support are thought to be of significance because they denote a price level at which the quantities demanded for the asset outweighs the quantities supplied.
Bullish traders are carried by a belief that the asset is cheap or it is likely to increase in price, when prices get close to a support level.
Therefore the asset price will invariably bounce back from this level of price and will form a stable range of price movement.
It is also utilized by investors when it comes to determining where exactly they can begin purchasing an asset.
If an asset’s price falls to a certain level and bounces up, it means that the specific asset is undervalued, and it is moments like these that the asset is believed to increase in price soon.
How to Identify a Support Level
To identify a support level, one must research the changes in price for an underlying asset for a given period.
There are many techniques and tools which help to identify levels of support. Here are some common ways to identify them:
1. Historical Price Data
The simplest way of determining the support levels is by taking a glance at the price chart of an asset.
Such investors study prior price patterns to look for levels where the asset has before experienced reversal or undergone changes and halted a continuing fall.
Such levels may be horizontal lines, which join the prior lows, or important troughs, in terms of price movements.
An example is the price range within a particular period of time; for instance, if a particular stock goes back to a certain price several times in the past few months and never touches that price again then that price is likely to be a support level.
The degrees of magnetism become stronger for each time the asset touches or gets within a specific price.
2. Trendlines
In technical analysis trendlines are drawn as lines on the price chart which join the previous low points in an upward sloping line whereas in a downward sloping line joins the previous high points.
By joining these points, one can draw a straight line that shows the price consistent pattern to the trader’s view.
A support trendline in an uptrend usually has an upward sloping pattern that suggests that pullback in the price is expected to find support in the trendline, buy opportunity.
The lower the price gets to the trend line, the Speculative will expect the price to bounce back and continue the upward direction.
3. Moving Averages
There are usually employed to establish dynamic support zones. The figure or rate is obtained after removing the irregular movements within a fixed period in the prices of an asset.
Simply the two most popular forms of-moving averages include the 50-day SMA and the 200-day SMA.When the price of an asset approaches a moving average and bounces off it, the moving average is often considered a dynamic support level.
Traders use moving averages to identify the overall direction of the market and predict when an asset may find support and reverse its direction.
4. Fibonacci Retracement Levels
Retracement is a technique employed by Fibonacci expert in identifying support and resistance levels of an asset.
It entails placing different essential Fibonacci levels on the price chart which include, 23 .6%, 38.2%, 50%, 61.8% and 78.6% as the levels of potential retracement in price after a previous trend.
Such patterns of Fibonacci retracement levels provide support to other indicators in development of support levels.
The failure of an asset price to bounce off an area of Fibonacci retracement and instead retrace the other way is a strong indication that the level being worked on is a valid support level.
5. Volume Analysis
The other level that is necessary for support determination is the volume. More people trading at a given price usually mean everyone is willing to buy at this price level and hence a strong support.
If an asset reaches a certain price level with more active buying rate it is an indication that demand for the asset is high and therefore a support level should be given importance.
On the other hand, low volume at support level implies that the price will pierce through the lower level and begin to fall.
Why Support Levels Are Important for Investors?
The truth is that each of the primary support levels represents a technically significant value for investors.
Knowledge of support levels is important to investors because they are useful in indicating an asset price change direction. Here are some key reasons why support levels are important:
1. Entry Points for Buying
Resistance level assist investors to determine areas where they can purchase an asset at a given arbitrary price. When they expect that an asset is near a support level and previous price action shows that the price had rebounded in the past then investors may buy the asset.
When an investor has purchased an asset around the support level, he or she is able to buy at a cheaper price hence raise the probability of a good trade.
That is beneficial for those that seek to invest and acquire shares at some point in time so that they can sell them at a higher price.
2. Combinations of Prices and Trend Reversal Signals
In fact, support levels are viewed as possible locations for the change of trend as well as prices.
If, for example, the price of an asset starts to move towards the important support level and starts to rebound, it means that a downtrend has completed and an uptrend begins.
Such a reversal pattern is very lucrative especially to investors who are able to identify this pattern at the right time.
For instance, for an extremely falling asset, but the asset bounces back at a certain price level, investors believe the price will increase after holding the price level.
Before making a decision traders use another technical indicators on equally high level to make sure that trend reversal really occurs.
3. Insurance/ Risk: Risk Management and Stop-Loss Placement
Support levels are important in risk management especially when setting stop losses because they guide the investors.
Stop loss order is a trade directive that specifies that an asset is to be sold when it gets to a particular price to reduce on losses.
The main advantage of a stop loss order just below the support level is that the investor is protected in the event that the asset price drops through the support level.
A support, which has been held, provides a safety net to look for, while a break below a support level means that one can bail out with stop loss in order to minimize losses.
4. Confirmation of Market Sentiment
Other supports are also depending on the market sentiment. If an asset is falling and holding support at some level then there is evidence that investors want this asset at that price.
On the other hand, when such a price goes below such a line and goes lower, it could be a sign that the market sentiment has changed deeper and may further decline.
Through using support levels and Market sentiment one can be in a better position to decide whether to buy, sell or even hold an asset.
Levels of Support and The Market Mood
This provides an insight of how psychological aspect of support levels can be brought into light to better understand why the levels are important.
This is not merely support as a figure on the chart but as a reflection of the cumulative sentiment of everybody in the market – the institutions, the small and big traders, the market markers.
It is the trigger point at which the market considers the existing asset cheap and this triggers buying.
When more buyers push through their demands into the market, the price either normalizes or rises.
This makes the voucher/GIFT to become self-reinforcing as the support level increases with more people accept the opportunity.
Still, it is vital to mention that support levels may be violated when the market sentiment flips massively.
For instance, where negative information or events triggers fear and panic then support could be broken to lead to lower levels.
Conclusion
Support level is widely used in financial technical analysis to find out the points when the entry should be made, to determine the risks, and predict the market trend.
With special relation to the formation of support levels and their place in the(and the impact on the overall markets), investors can make better decisions in regard to the buying and selling of assets.
Trend reversal and movement can be well understood with the help of support levels.
But they should not be used alone.
This support level analysis is used in conjunction with other technical factors or in combination with fundamental analysis before trading strategies are developed by successful investors.
Support levels together with other features of technical analysis play a vital role in facilitating profitable investment decisions in favourable or volatile circumstances within the context of the fast-flowing investment environment.
Summary
The support level in technical analysis is a price level at which an asset tends to stabilize and could embark on a recovery.
The identification of support levels is significant to investors because it allow them to recognize buying signals, understand risks, and make useful prediction.
Generally support levels are identified using price bars or boxes, trendlines, moving averages and Fibonacci retracement levels and volume.
These level are relevant in a way that they show where there can be more demand for the asset than supply, this finding a price at which people can start investing.
Support levels also come handy in risk management as investors can place sell orders below the support level in cases of stop loss.
It also important to examine the psychological aspect of support levels because the levels are the crowd mentality of the market.
FAQs
1. What does support level mean in technical analysis?
A support level is that point at which an asset is likely to experience demand on the buy-side, and any downward movement is arrested.
2. What principles do investors use to find support levels?
Areas of support are established on the basis of past prices, defined trends and moving average, retracement indicators and volume.
3. What makes support levels necessary for investors?
Technological support levels can assist in the search for purchases, in controlling risks, and in the definition of possible trend reversals.
4. In what manner do the support levels describe the price movements?
In case where an asset price gets close to a support level, it may rebound, which may signal either reversal or continuation of a pattern.
5. Can support levels break?
Indeed, if a bearish attitude towards the asset is observed, a breakthrough of the upward trend behind the support level may occur, which will lead to lower prices in the future.