Supports and Resistances
What is a stock price support?
A stock price support is a price level where the demand is strong enough to prevent the price from falling lower.
On a stock chart, typical supports are formed on an imaginary horizontal line on multiple lows at about the same price point. See below chart illustration.
What happens in a market situation when supports develop is when sellers try to drive down the stock prices but there are more buyers in the market who feel that at a certain price point, the stock is cheap and demand for buys are higher than sells which drive the stock price back up.
As seen in the above figure, the market is testing the price point three times before it shoots up higher towards the end of the chart.
Another type of support is when we are looking at an uptrending stock. In an uptrending chart, the supports are formed at the higher lows. Each time the stock zig zags upwards, the new higher low forms a new support. The uptrend will become invalid once the support is broken or rather the price fall lower than the support because the high low has been compromised. If you are in a long position, then it is time to exit your trade.
Figure: Uptrend Supports
In an uptrend, usually what is happening in the market is that the prices tend to climb to a certain point where buyers in position feels that they have gained sufficient and will like to start selling. While selling occurs, it will stabilizes at a point where buyers start to feel that the price is cheap again and continues the buy which then drive the stock higher. The retrace from high to low is called a correction. This is where the market readjust the price.
What is a stock price resistance?
A stock price resistance is a price level where the demand is strong enough to prevent the price from climbing higher.
On a stock chart, it looks like an imaginary ceiling that where stock prices will run up to a certain price, gets pushed down, climbs to test the price again but just fails to go through the ceiling. This process may repeat itself multiple times.
In a market situation, buyers are optimistic and drives the stock up. Sellers on the other hand out sell and drive the prices down. As this pattern repeats itself over a few times, it also creates a psychological barrier that the price will not go past the price ceiling. It may break the resistance if there is enough buyers convinced that the price should go higher and eventually over power the sellers. You may check out more in the break out section.
A downtrending resistance can be quickly illustrated in below chart.
Figure: Downtrending Resistance
As you can see, when a stock price goes on a downtrend, it will make a zig zag movement downwards, creating lower higher indicated with the green dotted lines. If you can recall, a downtrend needs to have lower lows and lower highs. Hence, with every lower high created, that forms a resistance for the downtrend to continue. Once this resistance is broken, the downtrend is no longer valid and it will be time to exit your short position trade.
When a stock breaks it’s downward trend, there are many possibilities that can follow. It does not only mean that it will make a reversal and change into an uptrend. It can go into a sideways channel, it can be a major correction which will lead back into a downtrend or it can also be just a false breakout.
Learn how to build a trading strategy based on breakouts.