Support and Resistance Levels

Support and resistance are the most fundamental concepts in technical analysis. These price levels act as "floors" and "ceilings" where buying or selling pressure concentrates. [DEFINITION] Support: A price level where buying pressure is strong enough to prevent further decline—a "floor" under the price. [DEFINITION] Resistance: A price level where selling pressure is strong enough to prevent further advance—a "ceiling" above the price. ### Why Support and Resistance Work These levels form from collective psychology: **Support forms because:** - Buyers who missed the previous low now want to buy - Sellers who sold too early regret and won't sell again at that price - Memory of the previous bounce creates buying interest **Resistance forms because:** - Buyers who bought at that level want to sell and break even - Sellers see the previous failure to break through and sell again - Short sellers enter expecting another rejection [EXAMPLE] Apple trades at $150, falls to $140, bounces back to $150, falls again to $140, bounces again. The $140 level is now established support—buyers repeatedly step in there. ### Identifying Support and Resistance **Previous highs and lows:** The most common and reliable levels **Round numbers:** $100, $50, $25—psychological barriers **Moving averages:** 50-day and 200-day MAs often act as support/resistance **Volume clusters:** Levels where heavy trading occurred **Trendlines:** Diagonal support and resistance [TIP] The more times a level is tested and holds, the more significant it becomes. A support level touched 5 times is stronger than one touched twice. ### Role Reversal [KEY] One of the most powerful concepts: When support breaks, it often becomes resistance. When resistance breaks, it often becomes support. [EXAMPLE] A stock breaks down through $50 support. Later, it rallies back to $50 but fails—$50 has now become resistance. Previous buyers at $50 are now trying to break even by selling. ### Trading with Support and Resistance **Buy Strategy:** - Buy near support levels - Place stop-loss below support - Small risk if support holds, big reward if stock rallies **Sell Strategy:** - Sell (or short) near resistance levels - Place stop-loss above resistance - Small risk if resistance holds, big reward if stock falls [EXAMPLE] Stock trading at $48, strong support at $45: - Buy at $47 - Stop-loss at $44 (below support) - Target $55 (next resistance) - Risk: $3, Potential Reward: $8 = 2.7:1 ratio ### Breakouts and Breakdowns **Breakout:** Price moves above resistance with conviction (usually high volume) **Breakdown:** Price moves below support with conviction [WARNING] Not all breakouts are real. "Fakeouts" occur when price briefly breaks a level then reverses. Look for: - High volume confirmation - Strong close above/below the level - Follow-through on subsequent days ### Measuring Support/Resistance Strength Levels are stronger when: - Tested multiple times without breaking - Formed on higher time frames (weekly > daily) - Coincide with other technical factors - Associated with high volume Levels are weaker when: - Only tested once or twice - Formed on lower time frames - Isolated from other confluent factors - Low volume area [EXERCISE] A stock has bounced off $80 three times in the past year and failed at $100 twice. It's currently at $92. What are your key levels, and what would you watch for? |ANSWER| Support: $80 (strong, tested 3 times). Resistance: $100 (moderate, tested twice). Watch for: 1) Break above $100 with volume = bullish, likely run higher. 2) Break below $80 = bearish, could accelerate lower. 3) Stuck between = trade the range buying near $80, selling near $100. [SCENARIO] You own a stock at $50. It rises to $60, falls back to $52, rises to $62, and now sits at $55. You see that $60-62 is resistance (failed twice) and $50-52 is support (held twice). Strategy options: - Sell some at resistance ($60-62 area) if it approaches - Add more near support ($50-52) if it pulls back - Use $48 as stop-loss level (below support) This is how traders use support/resistance practically.