What is Support and Resistance in reference to stocks?
Support and resistance form the foundation of all Technical Analysis.
Support – Any point where a falling stock price meets enough buyers to arrest the fall.
Resistance – Any point where a rising stock price meets enough sellers to stop the rising stock price.
Let me give some pictures to illustrate the difference between support and resistance
Technical Analysis: How to Calculate Support
As you can see in the picture above, the red line represents the support. As you can see with the circles, the stock price has bounced off of this support line 4 times in the last 4 months. The sellers have been unable to beat the buyers when the stock price approaches the support level.
Here’s another example:
In this example, you see it bounce 5 times in the last 4 months.
As the stock price falls, demand for the shares increases because of group psychology. This means that when the stock approaches the support line, enough buyers have the same opinion that together they are causing the price to reverse at the same point. The more times a stock bounces off of a support or resistance, the stronger this line is.
Both the support and resistance lines are not absolute points on a chart. When a stock approaches either line, maybe a bounce happens a few cents from the support or resistance. For example, let’s say support is drawn at $4.50 and the stock is approaching this line. It could drop to $4.45 and then bounce again when buyers overthrow the sellers. The point is, these lines are not hard drawn lines on a stock chart.
Technical Analysis: How to Calculate Resistance
So just like the support, the resistance acts as a line where the sellers take over the buyers and push the stock price down.
Here’s another example:
Okay. You get the point.
Now, if a stock breaks the resistance line, we could see it then act as a support.
Here is an example:
As you can see, the buyers overthrew the sellers the third time the stock approached the resistance. Then a month later, the stock price came back to that line but bounced off as a support. So these lines can be used in very long term plays, they will always be on the chart.
You have to remember that prices are driven by the actions of large numbers of people. So the likelihood of you being the only person that sees a support or resistance line is very slim because like it says in the first sentence in this post, “Support and Resistance forms the foundation of Technical Analysis.” Once again, these tools are not definite points on charts, so trade cautiously around them.