Foundations: Support and Resistance a Framework for Trading

We first introduced you to support and resistance lines in our Stock Market Made Simple blog, which you can read here. Today, we are going to dive deeper by introducing you to technical analysis.

Technical analysis is the study of a stock’s historical price points, which is displayed using graphical charts such as a candlestick chart. A technical trader believes the buying and selling pressure of the past can be tracked and provide an indication of a stock’s future performance and behavior. Therefore, by identifying and locating multiple points of buying support and selling resistance on a candlestick chart, we can mark or predict future trading behavior. After all, people are predictable, and history does have a way of repeating itself.

Building a Framework for Trading​​​​

Technical trading is built upon the idea of tracking reoccurring price points and using that data to plot and execute trades. The two central positions which technical traders look to identify are points of support and resistance.

​Support

Points of support show where a stock finds more buying pressure than selling pressure, and the buying pressure drive drives the price higher as there are more buyers of a stock than there are shares available. If we can connect the same points with a line, then it shows there is historical evidence for the stock staying above the price threshold.

In the example above, we have Amazon with three strong points of support. However, even with three solid connections, it is always good to remember these areas of identifiable buying pressure are only indicators of repeatable behavior that can be broken. Support was found around the thirty-three dollar price point during the months of October, March, and July. However, in the month of April, the stock did break below the thirty-three dollar mark. It quickly rebounded in a few days, but it did drop below the identified support. Again, support lines are strong statistical markers; however, they are not written in stone, and variances should be considered before trading off of them.

​Resistance

Points of resistance show where a stock finds more selling pressure than buying pressure, and the selling pressure drives the price lower as there are more shares available of the stock than there are buyers. As with support, if we can connect the same points with a line, then it shows there is historical evidence for the stock staying below the resistance price threshold.

In the example above, we have Disney with three points of resistance. However, even with three good connections, it is always ideal to remember these areas of identifiable selling pressure are only indicators of repeatable behavior which can be broken through. Resistance was found slightly above the hundred eighteen-dollar price point during the months of August, October, and November. However, in the month of October, the stock did break above the hundred eighteen-dollar mark. It quickly dropped in two days, but it did break above the identified resistance point. As with support, resistance lines are statistical markers; however, they are not written in stone, and variances should be considered before trading off of them.

In closing, when you identify and mark a stock’s support and resistance lines, you can see historical areas of buying and selling pressure. These areas of pressure are strong traditional indicators that you can use to help set up and exit your trades. Nevertheless, as shown in the examples above, variations can and will occur, so make sure you are protecting your positions with stops.