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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. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.



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. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance.


(charts from StockCharts.com)



The Strength of Support and Resistance

Trading Rules

1. Whenever the trend you are riding approaches support or resistance, tighten your protective stop. A protective stop is an order to sell below the market when you are long or to cover shorts above the market when you are short. This stop protects you from getting badly hurt by an adverse market move. A trend reveals its health by how it acts when it hits support or resistance. If it is strong enough to penetrate that zone, it accelerates, and your tight stop is not touched. If a trend bounces away from support or resistance it reveals its weakness. In that case, your tight stop salvages a good chunk of your profits.

2. Support and resistance are more important on long-term charts than on short-term charts. Weekly charts are more important than daily charts. A good trader keeps an eye on several timeframes and defers to the longer one. If the weekly trend is sailing through a clear zone, the fact that the daily trend is hitting resistance is less important. When a weekly trend approaches support or resistance you should be more inclined to act.

3. Support and resistance levels are useful for placing stop-loss and protect-profit orders. The bottom of a congestion area is the bottom line of support. If you buy and place your stop below that level, you give the uptrend plenty of room. More cautious traders buy after an upside breakout and place a stop in the middle of a congestion area. A true upside breakout should not be followed by a pullback into the range, just as a rocket is not supposed to sink back to its launching pad. Reverse this procedure in downtrends.

(comments from Dr. Alexander Elder)


For further education on Support and Resistance:
http://stockcharts.com/education/ChartAnalysis/supportResistance.html