A resistance level is the point on a price chart at which an upward price trajectory is impeded by an overwhelming inclination to sell the asset. If a market price is nearing a resistance level, a trader may opt to close their position and take the profit, rather than risk the price falling back.
The meaning of resistance level stems from market sentiment and trader behaviour, because it is an indication of whether an asset has reached a price level that market participants are unwilling to surpass – i.e. there is resistance from the market.
This means that resistance levels can be a key tool in technical analysis, along with support levels – which are the point at which traders are unwilling to let an asset’s price drop much lower. Traders will often identify areas of support and resistance in order to make decisions on trades, including the positioning of stops and limits. The overwhelming supply created at these levels can effectively become a self-fulfilling prophecy around price points.
The rapid increase in demand, as well as a decrease in supply, will cause a spike in the price – known as a ‘break out’. If an asset does breach its resistance level, then some traders believe it will carry on rising in price, or ‘rally’, until a new resistance level is found. At this point, it is common for the resistance level to become the new support level.