The Psychology Behind Support and Resistance

The reason that support and resistance work, and that the price will keep on touching and rebounding off them, is down to the psychology of the market participants. There is no ‘magic’, just commonsense. For the sake of this discussion, we’ll think of the people making the trades as three groups –

• People who have already bought the stock, and are ‘long’
• People who have shorted the stock expecting a downturn, the ‘shorts’, and
• People who haven’t made up their minds which way to trade, the ‘undecideds’

When the price is rising off a support level, they would be thinking like this –

• The longs are congratulating themselves, and wishing they’d bought more – maybe they will if the price goes back down to that level.
• The shorts are thinking that they may be wrong, and are hoping for the price to drop back down, so they can buy to cover their position, and get out of the trade without losing so much.
• The undecideds are thinking that they missed the boat, and resolving to buy shares if the price should come back down.

So all three groups are looking at the support level, and deciding to buy if the price comes back down to it. This demand for shares will force the falling price to reverse.

But what if the price falls through the support level? Suddenly, as they realize that the price isn’t stopping and reversing at the support level, everyone’s reaction will change. The thought patterns will be modified, so that –

• The longs think they must have made a mistake. They may hang on to see if they can sell at the support level, if the price comes back up.
• The shorts are congratulating themselves, and thinking that if the price goes back up to the support level, maybe they’ll short (sell) some more shares.
• The undecideds think that now they have missed out on shorting the shares, and resolve to sell short some shares if the price would only come back up to the old support level.

So suddenly, instead of buying at the old support level, and thus making the price bounce back up, everyone is thinking of selling if the price gets back up there – which makes the price go down. The old support becomes the new resistance, not by magic but by human nature. Technical analysis is a study of human nature more than a mechanistic process.

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