Support and resistance trading? The Basics

Support and resistance trading? The Basics

| Rich Clifford | Blog

Support and resistance trading? How do you determine support and resistance levels?

After the fact, of course.

Support and resistance trading are everyone’s first technical analysis terms. Today, they’re thrown around so constantly and carelessly that it’s easy to misunderstand them. Like a playground rumor, they began with a kernel of truth, were morphed into meaning something else, and are mostly childish nonsense.

A support level is a price point that an asset repeatedly drops to and then bounces back from. It’s usually accompanied by lots of trading volume, driving the price back up. A resistance level is the opposite: a price point that an asset repeatedly fails to break past. It’s also often accompanied by high volume, with traders taking profits and sending the price back down.

Breakouts and breakthroughs are what happens when a stock ignores (or pushes through or defies – whatever you want to call it) support and resistance levels. The typical line of thinking is that, since support and resistance are usually barriers to a trend, whatever trend was occurring will continue after a breakout:

If a stock breaks below support, then it’s going to keep going lower. The implication is that traders who were buying at that level have changed their minds or are out of the market. If a stock breaks above resistance, then it’ll keep going higher. Traders who were selling and taking profits have reason to believe it’ll keep going up, or have no more stock to sell.

Seems reasonable enough. On some level, this is all true, but it quickly becomes a backwards looking, subjective mess when you try to apply it yourself. Fortunately, there are plenty of trading prognosticators and algorithms who will attempt to do it for you.

Spotting Support and Resistance Trading in the Wild

A brontosaurus formation predicts that you’re spending too much time looking at charts.

It’s easy to spot other traders’ ideas of support and resistance levels: just look for lines drawn on a price chart. Traders are happy to share support and resistance levels after they’re established, and thus, have little predictive value. But, as with so much in the markets, support and resistance levels are what other people say they are – and they’re going to change their minds constantly. Don’t look for a single level to trade on for months or even weeks at a time.

On some traders’ charts, you’ll notice diagonal levels (“trendlines”) as well, meaning that the support and resistance levels are changing over time, adjusting to some unknown prevailing trend. Rare is the technical analyst who can actually explain these trends and how they relate to support and resistance.

Here’s how you could spot 3 different trends from one chart.

This graphic is definitely not financial advice.

The red line points to resistance at roughly 211. Since the stock is well below that resistance level now in March, it has “room to run” in the coming months.

The blue line indicates an alternating support and resistance level (more on this later) at roughly 200. After breaking out in October, there’s some evidence of support in late November and December before a breakthrough in January. Now, in March, this looks to be a resistance level. Now’s not the time to buy.

The green line indicates a downtrend, which showed some resistance in late September before it was broken through in October. Those early resistance levels are now support levels in the low 180s. If the stock dips to these levels, it will be poised for short-term gains.

Where Support and Resistance Trading Break Down

If you do a little homework, you’ll stumble on an “important technical analysis principle:” support levels eventually become resistance levels – and vice versa – over a long enough time frame. That is to say, “The pattern holds until it doesn’t. And then the pattern means the opposite.” Because support and resistance levels are perennially backwards looking, they have a way of tricking naive investors.

When you decide a support level has been established – that is, there’s a comfortable baseline that the asset surely won’t drop below – it may, in fact, have just become a resistance level. An upper maximum that just won’t budge. This happens time and time again because these simple patterns will always draw the attention of experienced traders and well-tuned algorithms. And by the time an opportunity is noticeable, it’s gone.

Everyone is acting on the same information – it’s our choice of tools that can make us successful. There are countless technical analysis tools out there that are only technically helpful. Support and resistance levels are just one more.

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