Technical Classroom: What is role reversal?
Motilal Oswal Financial Services
Support and resistance are basically specific price levels that prevent traders from pushing the price of an underlying asset in a certain direction. In other words, support and resistance levels are psychologically important levels where a lot of buyers or sellers are willing to trade the stock. When the trend line is broken, the market psychology shifts and new levels of support and resistance are established.
Whenever a support or resistance level is penetrated by a significant amount, they reverse their roles. This means a resistance level becomes a support level and support becomes a resistance level and really this concept works well in a technical trading system.
Let’s assume that the traders are divided in three categories. Those who are long, short and yet to decide what their next move is.
Let assume the market moves higher from a specific support level. If someone buys at that support level they are delighted, but at the same time they regret their decision of not buying more at the support level. So, when the market dips back to that support level, they could buy more.
Those who went short suspect that they are on the wrong side of the market and are hoping for a dip close to the area that they sold so they can get out of the market at the breakeven point.
The undecided realise that the market is going higher and they are willing to buy at the next good buying opportunity. So, they are all determined to buy the next market dip. If the price declines to that support level, all groups will go long and this will push prices up, which suggests more trading will takes place at that support level. This in turn makes that support level more significant.
Now let’s assume that instead of the market rising it trends lower. If prices fall below their previous support level, all traders who bought realise that they were probably mistaken in going long. Now, the three sets of investors will place a sell order on subsequent rallies or bounces at that level.
Example of role reversal: Equitas Holdings was facing resistance near Rs 150 levels from the past couple of months, but it surpassed the Rs 150 mark and retested that zone. This shows that initially what was acting as a resistance has now started acting as support.
Example of role reversal: RBL Bank has started to take support at its previous breakout zone, so a hold here could confirm a role reversal pattern.
Disclaimer: The author is Associate Vice President | Analyst-Derivatives at Motilal Oswal Financial Services. The views and investment tips expressed by brokerage houses on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.