Support And Resistance In Trading
Support and resistance is one of the most important analysis in the discipline of technical analysis. That is because when you do support and resistance analysis, you are actually studying price. Price areas can often act as a support that keeps the stock from dropping and also act as resistance that keeps a stock from rising. Various trading strategies can be formed by combining support and resistance with other technical indicators.
Why is it so important to study support and resistance?
Some traders make their living by trading off support and resistance points in the stock market. Since the major indexes do not trend as well as commodities, by studying support and resistance, the smart trader can profit by buying stocks when they are at support and selling (or shorting) stocks when they are at resistance.
For those who are new, let me introduce you to the wonderful world of support and resistance analysis.
Why is it so important to study support and resistance?
- It is pure price analysis compared to other indicators
- You get to see the footprints and actions of market participants
- You can form many trading strategies with support and resistance
- You can have confidence in holding a stock by studying support areas
- You know when to take profits early when you see a resistance area hanging above
Some traders make their living by trading off support and resistance points in the stock market. Since the major indexes do not trend as well as commodities, by studying support and resistance, the smart trader can profit by buying stocks when they are at support and selling (or shorting) stocks when they are at resistance.
For those who are new, let me introduce you to the wonderful world of support and resistance analysis.
What Is Support
Support is exactly what it means!
I want you to picture yourself about to fall backwards. Suddenly a friend holds your arms and back and keep you from falling. That is exactly what a "support" does. It keeps a stock from falling further.
I want you to picture yourself about to fall backwards. Suddenly a friend holds your arms and back and keep you from falling. That is exactly what a "support" does. It keeps a stock from falling further.
In the chart above, you can see how CA experienced a drop in late June. The drop must have been scary for those who are holding the stock. However, upon careful examination, an investor would have notice that there is ample support at the area and would have continued to hold on to the stock. Look how the stock found support at the area and rose from there.
In the chart above, you can see how AVGO dropped from April to May 2016. It might seem scary but the stock found support at the area and quickly rose from there. Just when you thought that the stock will rise further, it experienced another drop in June 2016. Part of the drop was the result of the BREXIT vote which surprised many. However, AVGO once again found support at the area and slowly rose from there.
The 2 charts above show the power of support area to a stock that is dropping. Support is an area and not a specific price point. The area itself is formed because of the past actions of market participants. Once a support area has been established, the likelihood of the stock continue to drop below the area diminishes. Even if the stock drop below the area, it will not be an smooth easy drop.
The 2 charts above show the power of support area to a stock that is dropping. Support is an area and not a specific price point. The area itself is formed because of the past actions of market participants. Once a support area has been established, the likelihood of the stock continue to drop below the area diminishes. Even if the stock drop below the area, it will not be an smooth easy drop.
What Constitutes Support
Now that you know that support is "an area that is likely to keep a stock from dropping further", the next question you need to ask is what constitutes support. I say 'likely' because no support area works 100% of the time. A gap down can occur or a bad news can make the stock dive straight below the support area.
What constitutes support?
Perhaps you can let me know if I have missed any. Anyway, knowing these 4 are more than enough for us to do support and resistance analysis. Let us delve into each one a little deeper so that you can understand more.
What constitutes support?
- Congestion areas / Trading Ranges / Boxes
- Previous Highs
- Previous Lows
- Gaps
Perhaps you can let me know if I have missed any. Anyway, knowing these 4 are more than enough for us to do support and resistance analysis. Let us delve into each one a little deeper so that you can understand more.
Congestion Areas As Support
Congestion areas are places where there is a lot of price action going on. That means the stock may have traded around the area for some time. For example, a stock may have traded around the $50-$60 price area for many months. That $10 price window is now an area that is called congestion areas. Just like a road that is congested or a place in town which is congested, there are many people there. In trading, a congestion area is where there is lots of price action there.
Congestion areas can also be called trading ranges. The price of the stock basically trade within a specified range for a period of time. Or it could be called boxes. Most of the time, you can draw a rectangular box on the chart to cover the congestion area. It is easier for the eye to see and do analysis and that is what I like to do in my Daily Stock Market Analysis. Just go through a few past stock market analysis and you will probably come across some boxes I draw.
Congestion areas can also be called trading ranges. The price of the stock basically trade within a specified range for a period of time. Or it could be called boxes. Most of the time, you can draw a rectangular box on the chart to cover the congestion area. It is easier for the eye to see and do analysis and that is what I like to do in my Daily Stock Market Analysis. Just go through a few past stock market analysis and you will probably come across some boxes I draw.
In the chart above, you can see a big congestion area from August to December 2015. The congestion area acted as a support area when the stock dropped in June 2016. Congestion areas can be very good support areas. The more heavily congested it is, the better the support will be.
The same story appears in the chart of HSIC above. HSIC formed an area of congestion from March to May 2016. When the stock dropped in June 2016, the congestion area acted as a support to the stock. Notice how you can draw a box around the congestion area. This helps the technical analyst to be able to see things clearer. When you draw a box, you can also see a trading range clearly.
The first time the stock dropped to the support area, it rose. However, the second time it dropped to the area, the congestion area was not able to keep the stock from dropping further. This shows us that technical concepts do not work all the time. Especially when it is the second or third time. Sometimes they can work many times and other times they don't perform at all the second time. With experience, you will be able to discern which is which.
In our case, the stock had a gapped down in August 2016 and this scared many people. When the stock continued to crash downwards, more and more people became concerned and soon many people were selling this stock. Too many sellers make the congestion area unable to keep the stock from dropping further.
The first time the stock dropped to the support area, it rose. However, the second time it dropped to the area, the congestion area was not able to keep the stock from dropping further. This shows us that technical concepts do not work all the time. Especially when it is the second or third time. Sometimes they can work many times and other times they don't perform at all the second time. With experience, you will be able to discern which is which.
In our case, the stock had a gapped down in August 2016 and this scared many people. When the stock continued to crash downwards, more and more people became concerned and soon many people were selling this stock. Too many sellers make the congestion area unable to keep the stock from dropping further.
Previous Highs As Support Areas
Previous highs in a stock can be support areas. They are weaker support areas especially if the high is made out of pivots instead of price consolidations or congestions. However, in an uptrend, a drop to previous highs is good enough to keep a stock from dropping. A stock that is in a stage 2 uptrend and drops to previous highs is likely to continue to move higher from there. To learn about market stages read The 4 Stages Every Stock And Market Goes Through.
In the chart above you can see how AMD found support at a previous high. Previous high works very well as a support in stocks that are in an uptrend. Since this is the case, you can often create a trading strategy that employs this principle. You can buy stocks in an uptrend that drop to a previous highs and ride it higher.
You might notice that I have added some lines on the chart. They are actually moving averages of the stock. I like to use 3 moving averages which are the 20 MA (red), 50 MA (blue) and 200 MA (yellow). You can learn more about moving average by reading What Is The Moving Average And How To Use It To Analyze Stocks.
You might notice that I have added some lines on the chart. They are actually moving averages of the stock. I like to use 3 moving averages which are the 20 MA (red), 50 MA (blue) and 200 MA (yellow). You can learn more about moving average by reading What Is The Moving Average And How To Use It To Analyze Stocks.
In the chart above, you can see how MU found support many times at previous highs. The stock found support at previous high in June and July. Once it started to rise, it once again found support at another previous high in Aug.
Previous Low As Support Area
Previous lows can also act as support. However, in my opinion, they work best in the first time the stock touches the low. It might work on the second time but the more times the stock touches the low area, the less the area will act as support because of absorption of demand. Besides that, when you are looking for support in a previous low, your stock is actually not in an uptrend. Your stock is probably dropping and you are hoping that it will reverse direction and bounce back up so that you can get out at a smaller loss.
Previous lows acts as great support if your stock is trading sideways at the moment. A stock that is trading sideways can be fertile ground for traders who like to use oscillators to buy oversold stocks. But do remember, the stock will eventually break out or break down and thus, a previous low will not act as a support forever.
Previous lows acts as great support if your stock is trading sideways at the moment. A stock that is trading sideways can be fertile ground for traders who like to use oscillators to buy oversold stocks. But do remember, the stock will eventually break out or break down and thus, a previous low will not act as a support forever.
In the chart above, you can see how CTSH found support at its previous low after the drastic two day drop in June 2016. The stock found support at its previous low. As I said earlier, if you are hoping to find support at a previous low, your stock is probably not in an uptrend and it is not a healthy, one. CTSH is definitely not a healthy stock at that time as it is below its 20 MA, 50 MA and 200 day moving average. You can read more about how to determine the health of a stock using moving averages by reading What Is The Moving Average And How To Use It To Analyze Stocks, How To Use The 200 Day Moving Average To Trade Stocks, How To Use The Moving Average Crossover, 50 Day Moving Average.
In the chart above, you can see DISCA dropped in June and found support at its previous low. The stock then rose higher from there and allowed those who are long the stock to recover some of their losses.
Gap As Support Areas
Gaps can be considered support area. A gap is where there is no trading taking place. Usually this happens when a stock has earnings or some news that make the stock open way higher than the previous day's close.
In the chart above, you can see how RAX gapped up in August. The stock then dropped to the middle of the gap and then it rose higher. Although not all stocks will find support at gaps, they are still watched by many traders. When the gap area coincides with previous highs or with some moving averages and the stock forms some bullish pattern, it can be a very potent support area.
If you study RAX above, the stock was dropping smoothly to its 20 day moving average. The stock also formed a doji pattern when it touched its 20 MA which point to a reversal. When you combine this analysis with gaps, you can be more confident that the stock will reverse and move higher.
If you study RAX above, the stock was dropping smoothly to its 20 day moving average. The stock also formed a doji pattern when it touched its 20 MA which point to a reversal. When you combine this analysis with gaps, you can be more confident that the stock will reverse and move higher.
Major Support And Minor Support
Now that you know there are 4 types of support, let us now move on to a deeper topic of major and minor support. A major support is more important than a minor support because of the significance that is attached to it. If a major support is broken, then it represents a serious shift in the health and direction of the stock. While there are probably many definition and interpretation of major and minor support, to me...
- Minor support are pivot points with not much price action there
- Major support are areas where there is a lot of congestion or a place where price has bounced off for many times
- Major support are also congestion areas in the weekly charts
In the chart above, you can see how DISH found support at a minor support. The minor support was a previous low with not much price action there. Minor support are pivot points that look like a "V" shape with not much price action.
Minot support are considered not very important if a stock is in a downtrend. But if a stock is trading sideways or better in an uptrend, then the minor support can actually be a very important point for traders who are looking to long the stock for a trade.
Minot support are considered not very important if a stock is in a downtrend. But if a stock is trading sideways or better in an uptrend, then the minor support can actually be a very important point for traders who are looking to long the stock for a trade.
In the chart above, you can see DLTR trying to find support at a Major support. I consider this stock to be in a major support because of the huge amount of trading and price action that congested for many months. Despite the gap down and recent drop, we expect DLTR to find support at a major support. Couple with the fact that it is near its rising 200 MA, the stock is likely to find support there and move higher.
In the event that the stock drops below the major support, then we can consider this stock to be in a very unhealthy state. Definitely not a stock that you should invest in.
In the event that the stock drops below the major support, then we can consider this stock to be in a very unhealthy state. Definitely not a stock that you should invest in.
The chart above looks the same as the rest but the congestion area is in the weekly charts. You can see how the stock at one point found support at the congestion are and rose higher from there. Congestion areas in weekly charts are very important major support areas as stocks usually find support there. That is why sometimes when a stock crashes in the daily charts, it quickly reverses from there. When you look at the weekly chart, you will probably see some heavy congestion area way left that you can't see in the daily charts.
Support As Demand
There is one more concept that I want to share with you about support. It is the concept of demand.
Support areas are actually demand areas. That's because there are many traders and investors who will be looking at the stock's chart. The reason why support and resistance works so well is because there are market players who will buy and sell based on support and resistance areas.
Support areas in the 60 min charts and daily charts will usually bring in traders, while support areas in longer term charts like the weekly and monthly charts are viewed by longer term investors. As you probably know, investors have more money than traders. It's difficult for investors or funds with a huge amount of money to buy things off 60 min charts or even daily charts. If they buy too much, they will probably make the stock move up by their buying.
But it is much more difficult to move things in a weekly chart. So, those who have a lot of money like big funds will more likely see things using the weekly charts. So, the next time you look at your stock, do move out to the weekly charts and note the support and resistance areas. Odds are you will find better support in the weekly charts for your trading.
Support areas are actually demand areas. That's because there are many traders and investors who will be looking at the stock's chart. The reason why support and resistance works so well is because there are market players who will buy and sell based on support and resistance areas.
Support areas in the 60 min charts and daily charts will usually bring in traders, while support areas in longer term charts like the weekly and monthly charts are viewed by longer term investors. As you probably know, investors have more money than traders. It's difficult for investors or funds with a huge amount of money to buy things off 60 min charts or even daily charts. If they buy too much, they will probably make the stock move up by their buying.
But it is much more difficult to move things in a weekly chart. So, those who have a lot of money like big funds will more likely see things using the weekly charts. So, the next time you look at your stock, do move out to the weekly charts and note the support and resistance areas. Odds are you will find better support in the weekly charts for your trading.
Resistance
This is a very long article.
If you thought that the concept of support and resistance can be tackled in a single 1000 words article, then you are in for a surprise. Even after you have absorbed all the education on this page, you still need to continue to study support and resistance on your charts. This technical concept is so important that if you are really serious about trading or analyzing stocks or the markets, you better study this properly.
Support and resistance is much more important than studying indicators like the stochastics or RSI.
So, what is resistance?
It is just the opposite of support with a little variation of its own.
If you thought that the concept of support and resistance can be tackled in a single 1000 words article, then you are in for a surprise. Even after you have absorbed all the education on this page, you still need to continue to study support and resistance on your charts. This technical concept is so important that if you are really serious about trading or analyzing stocks or the markets, you better study this properly.
Support and resistance is much more important than studying indicators like the stochastics or RSI.
So, what is resistance?
It is just the opposite of support with a little variation of its own.
What Is Resistance
Resistance being the opposite of support is an area where a stock will stop going up. Sometimes the stock will reverse when it reaches resistance area and then go down but sometimes the resistance just acts as a temporary barrier for the stock before it eventually moves higher again.
In the chart above, you can see how FOXA met resistance and fell from there. There is plenty of reason why the stock dropped at the area. First, there is a gap there. Gaps can act as support and resistance. Secondly, there is price congestion on the left. Then there is the 200 day moving average and the 50 day moving average right at the price which acted as a psychological and subjective resistance. You can read more about these two important moving average by reading How To Use The 200 Day Moving Average To Trade Stocks and 50 Day Moving Average.
Resistance has many implications to a stock depending on whether it is in an uptrend or downtrend. A stock that is in an uptrend and have a resistance overhead may find the upwards move much more difficult. Lots of resistance overhead needs to be absorbed and therefore, the stock will rise a few weeks, drop a week or two before rising again. A stock that is in a downtrend might rally to a resistance area and then fall from there. Thus, it gives the sophisticated trader an opportunity to short stocks that rally in a downtrend.
Resistance has many implications to a stock depending on whether it is in an uptrend or downtrend. A stock that is in an uptrend and have a resistance overhead may find the upwards move much more difficult. Lots of resistance overhead needs to be absorbed and therefore, the stock will rise a few weeks, drop a week or two before rising again. A stock that is in a downtrend might rally to a resistance area and then fall from there. Thus, it gives the sophisticated trader an opportunity to short stocks that rally in a downtrend.
What Constitutes Resistance
What constitutes resistance is just the same as what constitutes support. It just depends on where the stock is at the moment. Once you have studied support and what constitutes support, it is much easier for you to learn about what constitutes resistance.
What constitutes resistance?
What constitutes resistance?
- Congestion areas / Trading Ranges / Boxes
- Previous Highs
- Previous Lows
- Gaps
Congestion Areas Are Resistance
Once a stock drops below a congestion area, the congestion are now acts as a resistance.
In the chart above, you can see how MDRX formed a congestion area in January. Once the stock dropped below the congestion area, it acted as a future resistance area for the stock. When the stock rallied to the area, it found it hard to go any higher. The stock then dropped from there.
Previous Highs As Resistance Area
A previous high in a stock or index can act as a resistance area for the stock or index. The reason is because there are many people who have lost money near the previous high and are still holding it. When the stock or index moved back near the previous high, the holders who have lost money in the past are now getting their money back. So they sell the shares and this makes the stock drops. While this may not always be the case, the psychological impact of a previous high can be very great and it would be wise for any trader or investor to take note of a previous high especially if the stock has been rising for a very long time.
The chart above is something special.
It is the monthly chart of the S&P 500 from around 1997 to 2011. The S&P 500 made its high in 2000 and fell from there. It was the dot com bubble. Then it begin another bull market from around 2003 to 2007. The S&P 500 rose to around the previous high and it found resistance there. From there, the market dropped because of the financial crisis in the US.
Its amazing how support and resistance works on all time frames. I showed you a monthly chart of S&P 500 and the concept still works. Previous highs can act as resistance in all time frames. Whether it is the weekly chart, daily chart or 60 min chart, support and resistance still works. So the next time you see your stock reaching a previous high, be sure to take note of it. If you are long the stock, you might want to start selling some of it.
It is the monthly chart of the S&P 500 from around 1997 to 2011. The S&P 500 made its high in 2000 and fell from there. It was the dot com bubble. Then it begin another bull market from around 2003 to 2007. The S&P 500 rose to around the previous high and it found resistance there. From there, the market dropped because of the financial crisis in the US.
Its amazing how support and resistance works on all time frames. I showed you a monthly chart of S&P 500 and the concept still works. Previous highs can act as resistance in all time frames. Whether it is the weekly chart, daily chart or 60 min chart, support and resistance still works. So the next time you see your stock reaching a previous high, be sure to take note of it. If you are long the stock, you might want to start selling some of it.
Previous Lows As Resistance
For those who are new to technical analysis, this may start to be a bit confusing. How can previous highs and previous lows be resistance? Many stuff start to come up in your head and you become confused. But fear not, as you will read later when I explain how support once overcome becomes resistance, you will understand. You might want to read this article again and again until you understand everything.
For now,
A previous low once broken below, will be a resistance for a stock.
For now,
A previous low once broken below, will be a resistance for a stock.
As you can see from both charts above, once a previous low has been broken, the next time the stock tries to rally, it finds resistance at the previous low. Stocks tend to halt when they reach a previous low that has been broken. There are trading strategies which take advantage of this fact.
Gaps As Resistance Areas
If gaps can act as support, gaps can also be resistance areas. That's the wonderful thing about gaps.
Take a look at the chart of Google below.
Take a look at the chart of Google below.
Around April, Google had a gap down. Gap down usually happens because of earnings miss or some news that are important to the company. The stock later tried to climb back up but when it reached the gap area, it could not move any higher because of the gap. It is only much later around August that it was able to overcome the gap area.
Now that we have covered support and resistance, I would like to introduce you to two important concepts in support and resistance analysis. They are:
Now that we have covered support and resistance, I would like to introduce you to two important concepts in support and resistance analysis. They are:
- Resistance once overcome become support
- Support once broken becomes resistance
Resistance Once Overcome Become Support
In the chart above, you can see how the highs in 2012 acted as a resistance that prevented the stock moving higher for more than a year. INTC then broke out and overcame the resistance. In 2015 when INTC fell, the previous resistance now becomes support that kept the stock from falling further. Resistance once overcome now becomes support.
This concept works very well in longer term charts like the weekly charts and monthly charts.
This concept works very well in longer term charts like the weekly charts and monthly charts.
Support Once Broken Becomes Resistance
Support once broken will act as resistance. This is more potent if the support is a long time support or a major support.
In the chart above, you can see how MET found support at a previous low for a very long time. The stock was bouncing up everytime it reaches the support area and thus it traded sideways for a long time. Then in 2016, it broke support. The support became a resistance and kept the stock from rising when it tried to climb higher. Support once broken now becomes resistance.
Major And Minor Resistance
One last thing before we end. There are major and minor resistance. Major resistance are considered much more difficult to overcome than a minor resistance.
To me, major resistance are areas that have lots of price action and the area is very congested. A minor resistance is a pivot high or low that looks like a "V" which does not have much trading action and thus is easier to overcome.
To me, major resistance are areas that have lots of price action and the area is very congested. A minor resistance is a pivot high or low that looks like a "V" which does not have much trading action and thus is easier to overcome.
Summary
I know this is a very long article.
But you now have in your hands one of the most powerful tool in technical analysis. You can form many trading strategies and trade many stocks just using the technical knowledge of support and resistance.
Price is the only real support and resistance. Other stuff are subjective support and resistance although they also do work quite well because of their psychological effect.
This article is part of the series in How To Trade Stocks, A Step By Step Guide
But you now have in your hands one of the most powerful tool in technical analysis. You can form many trading strategies and trade many stocks just using the technical knowledge of support and resistance.
Price is the only real support and resistance. Other stuff are subjective support and resistance although they also do work quite well because of their psychological effect.
This article is part of the series in How To Trade Stocks, A Step By Step Guide
