Two of the most basic, yet effective, technical patterns are support and resistance.
These events are horizontal trendlines which cause a stock’s direction to reverse.
When prices are falling, support represents the moment when buying overwhelms selling and prices reverse.
Conversely, when stocks are moving higher, resistance is the point where selling overwhelms buying and the price increase stops.
Correctly identifying these trend changes will allow you to establish initial price targets and to develop your own sell discipline.
As with other patterns we have previously discussed, knowing the fine details of support and resistance levels will increase your chances of success.
Support and Resistance
Support is the price level at which demand is thought to be strong enough to prevent the price from declining further.
The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell.
Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further.
The logic dictates that as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy.
We must note that price continues to move between this support and resistance as long as the uptrend is in force.
Price will break resistance on the upside and will keep on making new highs.
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In a downtrend, when the price falls, it gradually violates one support level and goes to new low and accordingly carries on.
We should not confuse that resistance is a point which can only be challenged as long as the trend is up.
And support is a point which needs to be broken as long as the trend is down.
3 important Rules of Support and Resistance
1. Trends challenged – Support and resistance often act as decisive trend changers.
When an existing trendline meets resistance, be prepared for a dynamic shift.
2. Places change – If support is violated, that same level will act as future resistance.
3. Retests reinforce – The more often a trendline is tested, the more valid it becomes.
4. Volume reinforces – If a resistance or support level is associated with increasing volume, the trend becomes more valid.
5. Time matters – The more recently a level has been established the more useful it is.
A problem with the current bear market is that quick losses had many traders looking well into the past for support levels.
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Identification of key support and resistance levels is an essential ingredient to successful technical analysis.
Even though it is sometimes difficult to establish exact support and resistance levels, being aware of their existence and location can greatly enhance analysis and forecasting abilities.
If a security is approaching an important support level, it can serve as an alert to be extra vigilant in looking for signs of increased buying pressure and a potential reversal.
If a security is approaching a resistance level, it can act as an alert to look for signs of increased selling pressure and potential reversal.
If a support or resistance level is broken, it signals that the relationship between supply and demand has changed.