PART II: CHART PATTERNS
9 - SUPPORT AND RESISTANCE
Introduction:
In the financial markets, prices are driven down by excessive supply and up by excessive demand for a particular stock. Supply is synonymous with bears and selling. Demand is synonymous with bulls and buying.
Support and resistance represent the point where the forces of supply and demand are equal. As demand increases, prices advance and as supply increases, prices decline.
Support:
Support is the price level at which demand will overcome supply and prevent the price from falling further below. A breakdown below the support indicates the appearance of fresh sellers for a lesser price and lack of buyers at higher price. Once support is broken, another support level will be established at a lower level.
At times when price movements are highly volatile there may be a dip below the support level briefly and then the price will revert back to the support level.
Support can be established with the previous lowest price levels of the stock.
RESISTANCE:
As the price of the stock advances, sellers become more and buyers become less. Resistance is the price level at which selling is strong enough to prevent the price from rising further. When the price reaches the resistance level, the supply will overcome demand and prevent the price from rising above resistance.
Resistance does not always remain static and a break above resistance signals the appearance of new buyers willing to buy at a higher price and a lack of sellers to sell at a lower price. Once resistance is broken, another resistance level will be established at a higher level.
Price fluctuations can be volatile and rise above resistance briefly and shortly revert back to the original resistance level.
Resistance can be established by using the previous highest price level of the stock.
Mirror Image:
Support and resistance are like mirror images. Support can turn into resistance and resistance can turn into Support. Once the price breaks below a support level, the broken support level can turn into resistance. As the price advances above resistance the resistance level will turn into support.
Operators in the stock market use support and resistance lines to predict a possible trading direction of any particular stock. Support and resistance lines identify possible points where the market may change direction. The support line may connect all the lowest trading prices of a stock, while the resistance line does the same for all the highest trading prices of a stock. Once these lines are identified, investor may use them as a basis of buying or selling stocks.
Blow off tops or panic sell offs result in tops and bottoms in markets and they mark important support or resistance levels for a stock.
* To enlarge the chart Double click by keeping the cursor above the chart.
PUNJLLOYD SUPPORT AND RESISTANCE AT DIFFERENT LEVELS
Technique’s used to identify support and resistance levels:
An increasingly used popular technique for determining support and resistance are Fibonacci levels. These levels are imaginary levels based on Fibonacci number sequence and its ratios. Due to its widespread use, it is almost a magic ratio which causes prices to stop and reverse at these levels.
Many traders also use trend lines and other technical indicators such as the RSI, Slow Stochastic, Moving Averages, and CCI (Commodity Channel Index) to derive logical levels of support and resistance in a stock.
Gaps often act as powerful magnets for prices. It is a common observation in charts that all price gaps are most likely filled at some later point. The end of the bar prior to the gap is considered to be support on gap ups and resistance on gap downs.
Apart from this many traders, use whole numbers such as 10, 20, 50,100, and 200 to anticipate support and resistance levels.
Conclusion:
The art of making money in the market ultimately boils down to the identification of support and resistance levels well ahead of others. Though it still remains as an elusive horizon, in the forth coming chapters let us see how the above mentioned techniques will be of help to an ordinary investor.
Catching the top and bottom is next to impossibility while trading in stocks. You will be a very successful trader if you can trade somewhere near the top and bottom.
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30.12.2010
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