Support and resistance
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Support and resistance is a concept in technical analysis that the price of a security will tend to stop and reverse at certain predetermined price levels.
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[edit] Support
A support level is a price level where the price tends to find support as it is going down. This means the price is more likely to "bounce" off this level rather than break through it. However, once the price has passed this level, even by a small amount, it is likely to continue dropping until it finds another support level.
[edit] Resistance
A resistance level is the opposite of a support level. It is where the price tends to find resistance as it is going up. This means the price is more likely to "bounce" off this level rather than break through it. However, once the price has passed this level, even by a small amount, it is likely that it will continue rising until it finds another resistance level.
[edit] Identifying support and resistance levels
Support and resistance levels can be identified by trend lines. Some traders believe in using pivot point calculations.
The more often a support/resistance level is "tested" (touched and bounced off by price), the more significance given to that specific level.
If a price breaks past a support level, that support level often becomes a new resistance level. The opposite is true as well, if price breaks a resistance level, it will often find support at that level in the future.
[edit] Using support and resistance levels
This is an example of support switching roles with resistance, and vice versa:
If a stock price is moving between support and resistance levels, then a basic investment strategy commonly used by traders, is to buy a stock at support and sell at resistance, then short at resistance and cover the short at support as per the following example:
When judging entry and exit investment timing using support or resistance levels it is important to choose a chart based on a price interval period that aligns with your trading strategy timeframe. Short term traders tend to use charts based on interval periods, such as 1 minute (i.e. the price of the security is plotted on the chart every 1 minute), with longer term traders using price charts based on hourly, daily, weekly or monthly interval periods. Typically traders use shorter term interval charts when making a final decisions on when to invest, such as the following example based on 1 week of historical data with price plotted every 15 minutes. In this example the early signs that the stock was coming out of a downtrend was when it started to form support at $30.48 and then started to form higher highs and higher lows signalling a change from negative to positive trending.
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[edit] References
- John Murphy, Technical Analysis of the Financial Markets, ISBN 978-0735200661
