We have covered candles and candlestick charts in a couple of our earlier blogs. Now it is time to build on what we have learned and introduce the concept of support and resistance when analyzing a candlestick chart. And when I say analyzing, I really mean looking at a chart and trying to figure out exactly what the heck everything means.
Support can be identified on a candlestick chart as the price point a stock will historically struggle to drop below. These are known rallying points where buyers pull together and turn a fall in the stock price into an upturn. In the example below, you can see two areas of support where the price of Amazon stock dropped down to but quickly bounced back up.
The more buyers you have on a stock tends to drive the price higher, as more people are bidding on a smaller number of available shares. It can also be said, areas of support are known price points where investors find it very attractive to purchase shares of a company’s stock, especially when investors consider the perceived worth of the company in question. These points of support can be identified and tracked on a candlestick chart, and you can make statistically confident trading decisions based off them.
Resistance is where the price point of a stock will typically fail to rise above during a period of time. These are known rallying points where sellers exit their long trades and tend to turn a rise in the price point of a stock into a downturn. In the example below, IBM has one resistance line, which the stock does breakthrough but failed to stay above for an extended period. This shows support and resistance lines are not absolutes but are strong points of buying and selling pressure.
Thus the more sellers you have on a stock tends to drive the price lower as more people are selling their shares to a shrinking pool of buyers. Also, areas of resistance are known price points where investors find it very attractive to sell their shares of a company’s stock as they feel the price point is an overvaluation of the company’s perceived worth. These points of resistance can also be identified and tracked on a candlestick chart, which means you can make statistically confident trading decisions based off them.
The concept of support and resistance is central to the philosophy of technical trading. Remember, the more points of support you can find at the same price means the more likely a stock will not fall below the connecting time periods as pressure from buyers pushes the price of the stock back up. The reverse is true as well, the more points of resistance you can find at the same price means the more likely a stock will not rise above the connecting time periods as the pressure from sellers purchase the price of the stock back down. As with the IBM example, points of support and resistance are not unbreakable rules which are etched in stone. However, they are reoccurring price points, which can be very strong statistical indicators.