Determining Supports & Resistances through Moving Averages

Apurva Sheth
A few months back I spoke to you about Supports & Resistance and explained you how they are formed. I have also spoken about a couple of obvious places to look for supports and resistances. First amongst them are the previous highs and lows. When some time has passed after a new high or low has occurred the emotional factors starts affecting the market participants and general public at large. These levels then act as strong support and resistance levels. For example the 21,000 top of 2008 on BSE Sensex acted as resistance and remained unconquered for a long time.

Another point which can act as support or resistances are when prices are trading in a relatively tight band/range. A trading range forms when a stock or index is consistently moving up and down between two well-defined points for an extended period of time. These trading ranges are easily identified by simply observing price data on the chart.

Apart from this we have also seen how trendlines can act as support and resistances from time to time. We have also seen that trendline which acted as support or resistance earlier reverses its role and becomes resistance or support respectively.

As you are aware there are various ways in which one can determine support and resistance in an ongoing trend. Out of all these methods moving averages come in as a very handy tool to determine supports and resistances. One can use a moving average along with a trendline to identify supports and resistance. Moving averages can sometimes act as a substitute to a trendline.

What makes a moving average much more appealing compared to a trendline is its dynamic nature. Trendline are lines drawn between two points (high to high or low to low), hence they are static in nature. On the other hand moving averages are calculated considering the most recent price data as a result it indicates dynamic levels of supports and resistance.

Moving averages also overcome the subjectivity factor while drawing trendlines. Drawing trendlines involve a higher degree of subjectivity as the choice of the points to draw a line will differ from person to person. A moving average is open to customization depending on individual needs but it is still based on hard mathematical calculations which nobody can argue.   

I had illustrated the chart below in a previous article titled 'A good start is half the battle'. Here I showed you how angle of ascent becomes an important factor for stocks that are going through a phase of exceptional rise. At such times even valid trendlines are penetrated quite often by price.

Uptrend Lines drawn on daily chart of JK Tyre since September 2013 to December 2015
Source: Spider Software India

The stock price of JK Tyre rallied 10 times from September 2013 to December 2014. All the trendlines that I had drawn are valid but eventually all of them were penetrated by price. The penetration of the trendline is generally followed by a sideways consolidation which was later followed by an uptrend. The trendlines had little forecasting value and would probably get you out of the stock pretty soon.

Using a moving average in such instances would have helped you stay with the trend for a longer time. In the chart below I have added a 100 EMA on the price. You can see that apart from a blip in February 2014 the price has remained above the 100 EMA throughout this upmove.

JK Tyre with its 100 EMA
Source: Spider Software India

The 100 EMA does a good job of showing the medium term trend. But it still remains a bit away from price action to give any meaningful clues regarding supports and resistances. So we can use a shorter period moving average to check whether it helps us.

In the chart below I have used a 50 EMA on the same price chart. The 50 EMA does a fairly decent job of providing support levels during this uptrend on a number of occasions.

JK Tyre with its 50 EMA
Source: Spider Software India

However, even the 50 EMA like any other moving average isn't sacrosanct there will still be some instances when this or any other moving average will be breached. Ultimately a trader has to find a balance between reliability and sensitivity. Like always moving average should also be used in conjunction with other tools to identify support and resistance zones.

Do you use moving average to determine support and resistance levels? Share your views in the Club or share your comments here.

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2 Responses to "Determining Supports & Resistances through Moving Averages"
Byk Rao Ph.D.,
21 May, 2015
It is true that various moving averages(MA) act as support & resistance .Falling MAs act as resistance & rising MA as support .In the Indian context, share price moving above 50 DMA indicates intermediate bullish trend & .price crossing above 200 & 100 DMA, as long term bullishness, hence 100 DMA acts as a formidable resistance & support,where one can sell & make short term profits. All said & done technical analysis is a fascinating,interesting & profitable subject to study & apply. byk / Pune.Like 
ABHIJIT
20 May, 2015
ur articles r really interesting , i look at support with the 50 dma ,100dma,200dma & also look at the chart where maximum number of candles have been cut above the 50 dma as the resistance & support is it ok Like 
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