Support and Resistance
These are some of the most important lines you can have on your chart. They are the foundation for your trading. Other things, like indicators, you can do without, but support and resistance lines show directly the results of the supply and demand for a stock.
However, they can sometimes be the hardest to draw, as they are not just a calculated response. You have to decide where they should be positioned, depending on what you see on the chart. I’d say that you need at least two points to join, low points for the support line and two peaks for the resistance line, although some people will try to guess on the basis of one point, so that they can get in early on the lines. Anytime you get more lows or highs on the same line, then it strengthens your belief in the location being correct.
The support is the line along the lows that you don’t expect the value to drop below, as it has hit that level before and bounced back. The resistance is the opposite, a glass ceiling, which the value won’t go over. Of course, it can actually go over, as nothing is that sure in trading, but that starts a whole new pattern for the stock. Remember that other traders looking at these charts are thinking the same as you, so they will operate to validate these boundaries.
With the support line, the reasoning goes, the value has already gone down to this level, or tested it, and then it came back up. If it was worth it then, it is worth it now, so the value will rise again. The resistance line has a similar argument, in reverse – if it wasn’t worth going over that price before, then it won’t again, and the price will come back down.
While repeated ‘tests’ of the support and resistance line tend to confirm the position and values that the market thinks are correct, it is precisely from these posi-tions that a small move can start a breakout to a new set of values, so you need to be care-ful and use other indicators to confirm your view of the market.
There are actually a couple of ways to play with the support and resistance lines. If you draw them connecting successive lows and highs, which may mean that they are often not horizontal, and maybe not even parallel, then you can look for patterns. One of the formations that you can look out for is when the support and resistance con-verge, creating a triangle, and the expectation here is that the price will break out as it becomes compressed into a smaller and smaller range. The break out often follows the prevailing trend, and starts a new section of the price graph.
There is another way of looking at support and resistance lines that is popular with traders, and that is to draw them horizontal. This theory goes that when a rising stock breaks through the resistance line, and goes higher, then the previous resistance line becomes the support, and the price won’t drop back down – at least, unless there’s a breakout in a downtrend. So the price progresses in a series of steps. This method is also a valid use of the lines and you can try experimenting with it, and see if you find it easier to visualize. As with all these techniques, nothing is fixed and nothing is for always, so it’s fun to see what fits in with your personality and also works.