Trading stocks education - Trading tactics & examples
Support and Resistance
Think of security prices as the result of a head-to-head battle between a bull (the buyer) and a bear (the seller). The bulls push prices higher and the bears push prices lower. The direction prices actually move reveals who is winning the battle.
Support is commonly defined as "a price level or area
at which the demand for a stock will likely
overwhelm the existing supply and halt the current decline."
Resistance is defined as "a price level or area at which the supply
for a stock will likely overwhelm the existing demand and halt the current
Note that the words
"or area" are part of the definition. Support and resistance are not
"broken" by a one-penny
violation. They are areas. Think of them as rubber bands, not glass plates.
Note that the time frame matters also. A 10-cent violation of a 7-dollar
stock on a 2-minute chart may be a major violation. However a 50-cent
violation of the 200-period moving average on a daily chart on QCOM may be
nothing. It is very relative. From here on out for simplicity support will be
discused as though all the concepts apply in reverse for resistance. The charts
presented here are all the same chart, a daily of
the Nasdaq Composite, the COMPX, with a 20- and 50-period moving average.
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Notice on the chart
above that a form of support is identified: a rising moving average. Several
times the COMPX found support and rallied off of the rising 20-period
moving average. When this moving average is no longer serving as support,
it may be time to open a new playbook. Notice that the break of the 20MA
comes after a pullback, so good traders don't short there necessarily, but
the next rally is watched to see how it reacts.
Below you will see
examples of support found on a rising trendline.
A trendline must be
drawn on the chart to represent an area of consistently rising lows. While
there is an art to drawing these, for now you can see how this concept
works and how the trendline can often be similar to a moving average.
Next we have some
examples of major and minor support, forming horizontal support lines.
Note also that there
is what is called as major and minor support. Major support is a pullback to a
prior low to re-test that area. Minor support is formed by a pullback to
test a prior high.
In the first chart
above, notice the base that formed at the end of November. The pullback on
Dec. 20 was a test of minor support, the high of that base. Later, on Jan
16, the test was a re-test of that low area so it was major support.
Notice these two
areas. First they are areas, not exact numbers. Notice one support area
produced a bounce to new highs. The next one bounced one day and failed.
That is important to notice.
So what good is this
if you can't nail down support to a single penny, and if sometimes they
fail? Isn't trading supposed to be fool-proof? Well, it is when we get in
an area of support that we open up our playbook of bullish strategies and
wait for those strategies’ entries to hit.
Then we take the plays
that have good entries and proper stops. This lets the trades that work
give good results, and the ones that don't have small losses. The reverse,
of course, applies for resistance and bearish plays. It tells you the time
and area that you should look to use the strategies that you have learned
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