Support & Resistance
Support & Resistance
The price action of a security over a period of time will create strength at certain price levels. These levels are known as "resistance" at the top end of the range of trading, and "support" at the bottom end of the trading range. This trading range may develop over just a couple of months, or sometimes it can take a year or more to develop. This usually depends on the range the technician is examining.
For our example, we'll look at Air Canada stock. In the later part of the 1990s, Air Canada stock traded in a very narrow range of $5 on the low side and $7 on the high side, creating what we call support at $5 and resistance at $7. There was enormous support at the lower range because, over a long period of time, hundreds of thousands of shares had changed hands at or about the five dollar point, thus creating a very strong support level or "floor". Simply put, it would've required an extraordinary increase in selling activity for the price to fall below the $5 mark.
Conversely, trading activity at the higher price over the several years was at $7 - the stock price could not seem to break through this number. For whatever reason, the sellers would outnumber the buyers every time the stock price of Air Canada would climb to the $7 range. This "ceiling" or resistance created an interesting play for traders who recognized the trading pattern. They would buy the stock as it neared the $5 mark, and then sell it (and even go short) a few months later when it began to approach the $7 range. This awarded them with some very healthy profits.
As the price of a security breaks through the resistance level and moves to a higher ground, the level of resistance now becomes the level of support. A new level of resistance will then be formed at some point in the future. On the flip side of the coin, as the price range falls below the support level, that level then becomes the new resistance mark.
Understanding the concepts of trending and trendlines is important to learning about support and resistance. During a market trending to the upside, resistance levels are formed as the price action slows for an extended period of time. Pauses in the market often result from profit taking or near-term uncertainty for a particular issue or sector. The resulting price action undergoes a "plateau" effect or slight drop-off in stock price, creating an area of resistance. As a market falls off into a downtrend, the opposite occurs, creating levels of support.
I consider support and resistance vastly important. In my book its 3rd in importance to price and volume.Knowing where your resistance is at can save you from buying a stock at the top. ASDF stock has resistance at .99 but has been trading at .90 it moves up rather quickly to .97. Do not buy the stock at this price. Its infinitly better to wait and see if It can surpass its resistance. In most cases it will pull back at resistance allowing you to get in at a better price. Volume is going to play a roll here as well. Remember this on resistance most daytraders and swing traders will sell at the resistance level to secure their profits. They will continue to monitor to see if it breaks resistance and if it does and the stock is strong they may reenter.
Support is generally a time you want to think about buying. But its not foolproof. This is where other indicators play a roll.