Say, you are driving a car. You start the engine and put the car in first gear. The car runs smoothly till the speed reaches 20 km/hr. No much harder you try, the car speed won’t increase unless you change the gear.
Now, you change the gear and the car is in the second gear. Due to this, the speed limit has increased to say 30 km/hr. And if now you want to increase the speed further, you need to shift the gear to the higher side.
This is what happens to a stock in stock market. A stock which is moving up, will go up till it reaches a level where it has exhausted. This is called as ‘Resistance Level’. When we say that a stock price is showing resistance, it means that the stock has shown signs that it will not go up further. At resistance, one needs to sell the stock because it has little room left to run further.
However, when a stock crosses resistance, it means that it has entered into a new zone. Hence, there will be more chance of it moving further up. This is akin to the car shifting the gear to a higher number and hence the car can increase the speed till the limit is exhausted.
Whenever a stock reaches its 52 weeks high (which means the highest price in past one year), there will be more chance of it moving further up if it enters a new zone and an uncharted territory. Hence, one must buy when this happens. As the stock has got new legs to run.
2] UNDERSTANDING SUPPORT:
Say, you are driving a car uphill. Now, the car is moving slowly and steadily upwards. However, unfortunately your car runs out of fuel. Now, will you leave the car as it is and let it go down the hill with great speed or apply breaks and stop it midway?
Well, if you choose the later, then the car will stop at someplace and we can say that the hand break supported the car from falling further.
The same happens in a stock market. When a stock has fallen a lot, people who feel that the price is too low to fall further, start to buy the stock. This means that the stock price won’t fall at a certain limit. And this price level is called as ‘Support Level’.
One must buy at ‘Support Level’. This is because at this level there is more upside and less downside. Having said this, there are other associated risks too. Say, if a stock breaks it support level, this would mean that it has more room left for further downside. Hence, it will fall further, till it reaches a new ‘Support Level’.
Hence, they say, whenever a stock is at its 52 weeks low, investors must be cautious. Because, if it breaches the support level, then there will be more scope for it to fall further. So, buying a falling stock in hope of it finding the support is similar to catching a falling knife. The risk reward is high!
3] UNDERSTANDING CONSOLIDATION:
It is scary when a stock moves up or down fast in a short span of time. Hence, they say that for a stock it is very important to consolidate. Basically, ‘Consolidation’ means a stock is spending too much time in a particular zone. Hence, if the upper limit is crossed, we say that after spending too much time, the stock has now entered a new zone which will take it up further. Same is true for its downside.
A prudent person may think of buying cheap and selling at high price. But, when we study the technical terms like ‘Support’ and ‘Resistance’, we realize that when a stock crosses ‘Resistance’ it must not be sold even if the price is higher. As, it can move up further.
And when a stock breaches ‘Support’ it must not be bought even if the price is lower. As, it can go down further. In a way, we can say that there is little application of ‘Law of Demand’ in short run in stock market