In this article, we will discuss the concepts of support and resistance. The concepts of support and resistance are just a few of the many aspects of technical analysis. In technical terms, support and resistance are price areas where a large quantity of trading has taken place and where significant buying or selling pressure exists. In the most simplistic of terms, floors, and ceilings are points where the stock can be expected to stop falling or rising.
Significant selling occurs; price where you can logically expect the price to temporarily stop rising as the stock struggles to rise above this price. Many traders will use resistance as a point to exit a trade that is reaching its target (long stock or call option) or enter a trade once the stock breaks out of resistance.
Significant buying occurs; price where you can logically expect price to temporarily stop falling as the stock struggles to fall below this price. Many traders will use support as a point to exit a trade that is reaching its target (short sale or put) or to enter a trade once the stock breaks through the area of support.
Once areas of support and resistance are identified, you are not surprised when prices rise to an area of resistance and then stops. You actually expect this to happen. Conversely, when stocks are falling, you know there is a high probability that the stock will continue to fall until it hits an area of support. You then know there is a good chance that the stock will bounce off the area of support, at least in the short term. The key then is to learn to identify where floors and ceilings are on a chart.
Identifying Floors and Ceilings and Determining their Strength
Like most aspects of technical analysis, you look at past price action to help you determine where areas of support and resistance exist. How has the market reacted when the stock has reached certain price levels? Here are a couple of key points in helping identify where areas of support and resistance are and the potential strength of each:
- Support and resistance levels should not be viewed as an exact price point but should be viewed as general price levels where stocks stopped rising or falling
- The more times this price level is tested the stronger the area of support and resistance is.
- Volume can play a critical role in determining whether an area of support or resistance is penetrated. The penetration of an area of support or resistance on high volume can indicate the possible breach of the area of support or resistance. Conversely, stock bounces off of areas of support or resistance on high volume can be a signal of confirmation of the strength of that area of support or resistance.
It is worth repeating that areas of support and resistance should not be viewed as exact price points but should be instead be viewed as general price levels where stock stopped rising or falling. Too many novice traders fall into the trap of viewing technical analysis as an exact science and in the excitement of learning about support and resistance want to determine to the penny where support and resistance levels are located. Do not fall into this trap, and in your trading notes simply make note of the general area where support and resistance is located.
For example, if a stock has reached approximately $70 three different times in the past few weeks and stopped moving higher, it can be said that the stock has a resistance area of $70. Likewise, if each time that same stock fell to approximately $60 and each time the stock stopped falling, you would make a note that the area of support was approximately $60. You could simply make a note in your trading notes:
- Company XYZ
- Current Ceiling – $50
- Current Floor – $45
Once you have learned to identify support and resistance areas for a stock, you have gained powerful information in which you can base your trading decision on. In conjunction with trends, support and resistance serve as part of the foundation of technical analysis.
- Jonas Taylor is a financial expert and experienced writer with a focus on finance news, accounting software, and related topics. He has a talent for explaining complex financial concepts in an accessible way and has published high-quality content in various publications. He is dedicated to delivering valuable information to readers, staying up-to-date with financial news and trends, and sharing his expertise with others.