Share Market Toolbox
The concept of support and
resistance on a share price chart is very
Understand what it is
and how to utilise it. Read on...
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Related links: Stop Loss; Trends and Trend-spotting; Dow Theory; Weinstein's 30-week MA;
Don't forget that price charts capture and summarise the underlying opinions and emotions of the market participants. Every chart tells a story, and it pays to understand the stories in the price charts.
What is resistance?
In simplistic terms, a resistance level forms and becomes apparent on a price chart because there is reluctance amongst traders and investors (the market participants) to hold the stock above the resistance level. That is, they don't believe that it is worth any more than this price. And it often tends to be a whole number of dollars (such as $12.00).
What is support?
A support level forms and becomes apparent on a price chart because there is general agreement amongst traders and investors (the market participants) that a stock is worth more than a particular price point - the specific support level. On a price chart the support level appears to be a floor under the price, such that as the price falls to this level, it then rebounds up and away from that level.
A trendline is also support
A rising trend line (as shown with the sloping dashed line in the above sample price chart and labeled "5") also seems to act as a floor under the price, and is considered a support line. As the price rises, the rising trendline appears to act as a floor and the price appears to bounce up off the support line.
Change in polarity
It is common for a specific resistance level on a price chart to eventually become a support level. This happens because of the psychology of the market participants, and simply reflects their collective opinion and sentiment. That is, once the share price has broken above a resistance level, sentiment often switches so that the same level is then the support level above which people will buy.
Fat pencil - a resistance 'zone'
When identifying and drawing a support or resistance level on a price chart, it is sometimes useful to draw it with a fat pencil. For a price chart of a company, the sentiment and opinions of the market participants are often flagged at precise price points. However, especially on a chart of a market index, the support or resistance level can actually be a wider zone on the chart. In this case, it is appropriate to draw the support or resistance level with a 'fat pencil'.
Past levels become future levels
One phenomenon that is often observed is that a support or resistance level in the past will also be a support or resistance level in the future. In some cases this is due to the psychological impact that a number of investors had bought at the previous level, only to see the price fall away. Their desire is to recoup their losses by simply selling the next time the price reaches the same level. So, when the price rises again to that level, they will all be queuing up to sell, and this selling pressure can be enough to stop the price rise.
Many chart patterns such as triangles, pennants, wedges, flags, double tops and bottoms, and so on, all have price ranges on the chart where a straight line can be drawn across the chart as either a support line, or a resistance line. In some chart patterns there is one of each type that envelopes the price action.
Which charts? daily, weekly, monthly?
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TerminologyAny special terms that might be used in the text at left, can probably be found discussed in the Toolbox somewhere. Perhaps in Brainy's eBook Articles - see the Master Index list for details. Or, search the eBook Articles.
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