Support and Resistance resistance lines identify price tendencies in the price action of a stock or commodity. These lines are often observed on stock charts. It is important to understand where to find support and resistance levels as they are areas where can buy or short stocks with minimal risk. The following information will guide you in understanding support and resistance on stock charts.
Support and Resistance Definition
A. Support is an area or price level where the price action stays above. Sometimes the price may bounce off and climb higher from these levels.
B. Resistance is an area or price level where the stock’s price action peaks then proceeds to go lower.
Support and resistance is the most basic and essential analysis tool that every trader should be familiar with. When you study this form of technical analysis, you will be able to spot price tendencies, lower your risk, and define areas to execute a trade.
How To Draw Support And Resistance Lines
Drawing these lines are simple if not self explanatory by taking a closer look at the chart above. When drawing support lines, you want to connect the low prices that repeat twice or more. When drawing resistance lines, connecting the price peaks will define the resistance levels. Keep in mind that the chart above is a “perfect example” and there are times when price levels aren’t exact. Support and resistance lines are meant to define “areas” , not an exact number. In the chart above the support level might be $27 or $29 depending on how volatile the stock’s price action is.
Chart Analysis: The stockchart above displays Starbucks Coffee over a period of 3 years. We can see that the price action climaxed at around $38 then later again which defines resistance level B. The repetitive nature of the price action can define the resistance level. The stock is showing support as it bounces of the $28 level. Again, you can say that the price action has tested the $28 level for support then later the support level was breached signaling the start of a new down trend in the price action.
When Support is Lost there is opportunity. In the the chart above we can see that SBUX started to trade below the the $28 support level. This signifies a “change” in trend, and momentum increases downward. Typically short term traders will seek opportunity by trading inside these support and resistance levels.
In Breakout theory we seek to trade for the major move, and capture a long lasting trade that will bring maximum profit. So when a stocks price action “breaks out” of a trading range like above, we trade in that direction. In the case of Starbucks above we would short sell stock, or sell out of long positions.
Why Support and Resistance lines are Important: Risk should be #1 concern when trading stocks. By trading only at the areas of support and resistance are you able to keep risk at minimum. By simply selling out of your position if the price action moves to the other side of the support or resistance area. No single trade should wipe you out. When the losing streak happens, you will still be in the game. All traders go through a losing streak, so always keep the size of your trade consistent and manageable should the market go against you.