Support and Resistance


Support and Resistance


Support and Resistance exist because people in the stock market have memories.

Huh?

Well our memories prompt us to buy and sell at certain levels. And this buying and selling by mass stock traders creates support & resistance.

If a stock traders remember that prices have recently stopped falling and turned up from a certain level, they are likely to buy when prices approach that low level again.

On the other hand, if stock traders remember that an uptrend has recently reversed after rising to a certain peak, they tend to sell and go short when prices approach that high level again.

In the stock market, stock prices are driven by supply and demand. To much supply is synonymous with selling and the price dropping, while over demand is buying and the price rising.



When supply and demand are equal, the stock prices move sideways as the bears and bulls battle for control.

Support and Resistance levels exist because masses of traders feel pain and regret. It’s crowd psychology.

In up-trends, stock traders who sold short feel pain as the share price rises and they are losing money, and traders who bought long feel regret that they did not buy more. Both are determined to buy if the market gives them a second chance.

Bear Pain


The pain of bears and regret of bulls make them ready to buy, creating support during dips down in an uptrend.

In other words, when the share price drops to the level that the Short Sellers initially sold short at, the re-buy their shares at that level to break even. Meanwhile, the Long Buyers will buy more shares at that lower level they originally bought at.

Both actions are of buying, therefore demand outweighs supply, and the share price rebounds back up again…it bounces off a price support level.



Resistance is an area where the bulls fell pain, bears feel regret, and both are ready to sell.

When prices fall from a certain peak price, those who bought at the price feel pain as they are losing money, and wait for the share price to rally back up to that level so they can sell and break even. The Short Sellers feel regret that they had not shorted more, and will sell short more when the price to that original higher level again.

Both actions are of selling, therefore supply outweighs demand, and the share price rebounds back down again…it bounces off a price resistance level.


In the end, the strength of support and resistance depends upon the strength of feelings among the mass of the traders.

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Trading Support and Resistance

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Trading Range


The above chart shows a large price rectangle trading range. Support was established with the low in October at $33. In November, the price hit $42, and then quickly the stock returned to support at $33 in December. It bounced back up to $42 in January, and then down to $33 again.

After each bounce off support, the stock returned all the way up to the resistance level.

When the stock failed to advance past $42, the resistance level was confirmed. The stock subsequently traded up to $42 two more times after that and failed to pass resistance both times.

After a resistance level is broken, it can turn into a support level, and visa versa.

Support Turned Resistance


The stock price break of support, signals that the forces of supply have overcome the forces of demand. Therefore, if the price returns to this level, there is likely to be an increase in supply, as explained above, hence resistance.

Contrarily, is resistance turning into support. As the price advances above resistance, it signals a change in supply and demand. The price breakout above resistance proves that the forces of demand have beaten the forces of supply. If price returns down to this level, there is likely to be an increase in demand, and supply will be found.

Moving averages also can be used to identify key support and resistance levels.

Strength of Support or Resistance

The more times that a stock bounces off support and falls back from resistance, the stronger these support and resistance levels become. It creates a self-fulfilling prophecy. The more often it happens, the more likely it is to happen again. The more those historical patterns repeat themselves, the more traders "know," and the more confident they become in forecasting the future behavior of the stock. Some stocks become so entrenched in this trading range, that the stock eventually has a hard time breaking through the levels to either the up or downside.

Using Support and Resistance

Long traders will often set a protective stop slightly below one of the support levels, and short sellers will often set their stops just above resistance. The reason for these stop levels is because investors "know" that historically; these price points are unlikely to be violated. When either of these points is exceeded to the point that stops go into effect, then there is the potential for a powerful price move as automatic buying or selling is set into motion by the stops being triggered.


Trading Range

Trading ranges play an important role in determining support and resistance as either price turning points, or price continuation patterns. A trading range is a period of time when stock price move move within a relatively tight range.

This signals that the forces of supply and demand are evenly balanced. When the price breaks out of the trading range, up or down, it signals that a bull or bear winner has emerged.


Support and Resistance Trading Rules


1.Whenever the trend you are riding approaches support or resistance, tighten up your protective stop. Or be mindful and aware of the stocks action when it approaches theses levels…watch your asset!

2.Support and resistance are more important on long-term charts than on short-term charts. Weekly charts are more important then daily. If the weekly trend is sailing through a clear zone, the fact that the daily trend is hitting resistance is less important.

When a weekly trend approaches support or resistance, you should be more inclined to act.

3.Support & resistance levels are a useful price location for placing stop-loss and protect-profit orders.


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Conclusion

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Identification of key support/resistance levels is essential to successful technical analysis.

If a stock price is approaching an important support level, it can serve as an alert to be extra mindful in looking for signs of increased buying pressure and a potential reversal.

If a stock price is approaching an important resistance level, it can serve as an alert to be extra mindful in looking for signs of increased selling pressure and a potential reversal.

If support or resistance is broken, it signals that the relationship between supply and demand has changed. A resistance breakout signals that the demand (bulls) has gained control and a support break signals that the supply (bears) has won the battle.




Technical Analysis of the Financial Market


For further in-depth information, the book Technical Analysis of the Financial Markets by John Murphy, contains everything you need to know to help you learn to use and read stock charts and stock technical analysis in a clear, simple and concise manner to improve your stock trading success.





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    Trend Lines


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