Support and resistance
Price zones where a move has stalled repeatedly in the past. Their effect rests partly on actual orders, partly on self-fulfilling expectation.
When a price has bounced upward at the same spot more than once, that spot is called resistance. Bounce downward more than once, and it's called support.
There are two explanations for why this happens. First, actual orders sit there, say from people who wanted to sell at that price. Second, many people watch the same charts and so trade at the same spots.
The second point matters and often gets misread as a criticism. A level working because many people believe in it doesn't make it worthless. But it does make it dependent on enough people continuing to believe in it.
In practice these are zones, not lines. Expect a price to turn on the exact cent, and you'll be disappointed. And the more often a level gets tested, the weaker it usually becomes, since the orders sitting there get worked through.
The effect can be explained through the distribution of entry prices. At price levels with high historical volume, a large number of positions with a similar entry price exist. If the price returns to that level after a decline, selling pressure emerges from investors wanting to exit at breakeven, which slows the advance.
Empirically, testing such levels is methodologically demanding, since identifying them involves degrees of freedom: which turning points count, how wide the zone is, how many touches are needed. Choosing these parameters after looking at the data creates overfitting, and the apparent hit rate carries no predictive value.
At breakouts, a role reversal is often described, where broken resistance becomes support. That observation is consistent with the entry-price-distribution explanation, since after the breakout, positions sit on the other side. Reliable statements about frequency, though, require a predefined definition of a breakout, including minimum distance and confirmation duration.
Summary
- They're zones, not lines.
- Their effect rests partly on entry prices, partly on shared expectation.
- Choose the parameters after the fact, and the result carries no meaning.
Did you get it?
Why does a past price level slow an advance?
Because many investors have a similar entry price there and tend to exit.
Why is empirical testing difficult here?
Because identifying the levels involves many degrees of freedom, which easily lead to overfitting.
What typically happens when a level gets tested repeatedly?
It weakens, since the orders sitting there get worked through.