How are Support and Resistances formed?

It is easier to understand this concept by means of an illustration. Given below is the weekly chart of the S&P 500 from mid 2018 to end 2019.

The area of 2900 to 2950 has been a key area to determine the direction of the index.

The first time it traded in this area, it pulled back 17% to 2400.

The second time it traded in this area, it pulled back 7% to 2730.

Let us consider a scenario in June 2019 when the index was back in the same range of 2900 to 2950.

The market participants can be divided into 3 groups, those who bought in this area, those who sold in this area and those are waiting on the sidelines. By July 2019, the index was trading around 3030. up about 3% from the initial level in June. The index was looking bullish. Those who bought in June are happy and would buy more if provided another opportunity, those who sold in June feel the market is getting away from them and would like to exit their sell positions at the next available opportunity. Among those on the sidelines, these can be further divided into 2 groups, those who exited all their current positions and those who are waiting to get into the market. Both groups notice the bullish sentiment of the market and would take buy positions at the next opportunity.

There is “buying interest” from all 4 groups at the trading range of 2900 to 2950. When the index dips back to this range, this area becomes a support area from which the market climbs to make new highs.

This illustration explains how a support area was formed. A resistance or “selling interest” is formed similarly by the 4 groups of market participants at a certain area if the index had moved lower from that area.