When Expensive becomes Cheap: Resistance Turn Support

Related article: Understanding Support and Resistance (S/R).

Prices breaks above Resistance level

In the past 12 months, the retail price of apples has been ranging between £0.50 (Support) and £0.75 (Resistance) in a specific market. One day, there were rumours about a local government initiative to increase the price of fruit fertilisers. This would have a direct impact on the cost of apple production and subsequently its end market price.

Hearing about this, the locals (buyers) decided it was wise to stock up on apples before any price increase. With everyone having the same idea, all of a sudden apples were being purchased in plentiful quantities. This quickly led to demand peaking above supply. Now, with a shortage of stock, sellers had no choice but to increase the price of apples above the normal range price of £0.75.

The following is a chart of Apple prices 6 months on.

(Click on image for Larger View)

When Expensive becomes Cheap

Let’s take a dive into the buyers’/sellers’ minds.

After the rumour, price went above £0.75 i.e. it broke through a psychological (Resistance) level. From that point on, buyers had no choice but to pay more than £0.75 for an apple. Nonetheless, they could still decide what price was deemed expensive and in the immediate term, they were only willing to pay £1 or less for an apple. As time goes by, prices formed a new range (orange box) and it only bounced between £0.75 and £1.

The notion of “£0.75 is the most expensive price” was from the past and was no longer valid. Instead, buyers now felt that £0.75 was “cheap” relative to £1. So now, every time the price hit £0.75, buyers would start buying more apples, inevitably pushing the price of apples up again.

Without realising it, £0.75 (old Resistance) became the new Support level. Meanwhile, £1 became the new Resistance level.

As seen on the chart, this process continues to repeat itself at each trading range (the horizontal lines being S/R levels). Sometimes, buyers and sellers would react very quickly on S/R levels and this is represented by sharp bounces at price levels (red and green arrow).

The above is an example of prices going higher. The same applies when prices are going lower. Hence, the opposite is true when Support turns into Resistance.

Why Will This Work Again?

Rumours or news are often the catalyst for price change. However, the real cause of the price increase was the consumers’ own psychology.

With the rumour, there was Fear. The consumers decided to buy more apples as they were worried that prices would increase immediately.

When £0.75 turned from expensive to cheap, there was Greed. Consumers thought apples were cheaper “now”, so stocked up on more than they needed. This sudden and overwhelming demand for apples left sellers unprepared, thus, forcing them to increase prices.

In short, the concept of Support and Resistance is really driven by human psychology and more specifically human emotions. This will work again (and again) because of human emotions and even though I’m not a psychologist, I strongly believe that human emotions will not change for a very long time.

Thank you and happy trading!