Facebook
Twitter
Maybe the most talked about topic in the technical analysis universe, but the least well understood, is that of support and resistance. What it is and how it’s used, we elaborate on hereunder.
In a nutshell, support and resistance are the chartist’s words, respectively, for demand and supply. When a stock rises repeatedly to, say, $50, and then falls back below that level, it’s because sellers are dumping their wares at that point. The $50 mark comes to be known as “resistance” because there’s a great supply of stock that comes to market at that level.
Conversely, the point where a consistent demand for a stock is found and buying regularly ensues comes to be known as “support.”
Moving Targets
As the following chart of Wal-Mart (NYSE: WMT) shows, support and resistance levels are not static affairs, in the least. Rather, they are regularly shifting, and can be discerned by technicians on an hourly, daily or weekly basis.
Take a look below at support and resistance levels for Wal-Mart for a little over two years.
Between May 2005 and March 2006, Wal-Mart traded in a range between $51 and $58. But in late March 2005, support broke on big volume (in black). At that point, as you can see, buyers dried up, and a massive round of selling began. Former support at $51 turned into major resistance for the next 18 months (at right). And eventually traders found a new key level of support just above $42.
That’s a fairly standard occurrence – support becoming resistance, and vice versa – and traders should make themselves aware of existing support and resistance levels for precisely that reason: they make excellent entry and exit points for trades.
Straight Lines and Even Numbers
Where are support and resistance found? As above, they’re often determined without recourse to anything but the charts at our disposal and a regular diligent mapping of prices.
But they also reside in trend lines or trend channels, as seen in the chart below.
Using the trend channel as a guide, a trader could confidently place his buy orders at the low end of the channel (support) and his sell orders at the top (resistance).
The chart also shows how a moving average, in this case the 200-day moving average (in blue), can act as a significant line of support. It’s the best of all worlds, of course, when the two support indicators are working in tandem, as seen above.
Other places where support or resistance are found are:
- Where previous highs or lows were set.
- At round numbers, like $50 or $100.
It’s not so clear why round numbers would trigger buying or selling; it’s likely more a matter of investor psychology than anything fundamental. Many market participants say, “I’ll buy when Hasbro hits $50 or $75 or $100.”
There’s nothing rational here, just the capricious nature of the human animal, deciding arbitrarily that the time has come to take action. But collectively, it has an impact, to be sure.
One of the market’s best-kept secrets
For over 40 years this powerful income strategy has been hidden from you by professional traders and fund managers. It can hand you thousands of extra dollars every month—with just a few simple clicks. “Big Dog” investors like Warren Buffett use this secret strategy all the time. Now we’ll show you exactly how it works. Click here to get started.