Let’s talk about Support vs. Resistance as it applies to choosing stocks to trade
When it comes to stock trading, support vs. resistance are two extremely important concepts that traders need to know inside out. Understanding them can make the difference between success and failure, and being able to use them effectively in technical analysis is an integral part of the path from novice trader to expert.
The good news is that the basic concepts are very easy to grasp. Start with a definition: Stock resistance can be defined as the top price of a stock over a specified period of time. Conversely, support is the lowest price over that same period. Another way to look at it is to think of resistance as the ceiling price for that same stock, with support being the floor price.
To understand how support and resistance function together in the real world, they can easily be tied to the idea of supply and demand. In this model, resistance is the price point at which demand tops out, while support is the point at which demand is strong enough to keep the price from declining. Supply simply refers to the number of shares of stock available for trading.
To illustrate, consider the simple example of a stock whose price fluctuates between $20 and $30 over a 90-day period. The $20 figure would represent the support point of the stock (i.e., the floor), with $30 being the resistance point (the ceiling).
Using support and demand to trade effectively is where things start to become more complicated. They both play an important twin role in technical analysis, particularly when it comes to using trend lines in support and resistance charts.
These charts and the lines they contain provide a graphical representation of the performance of a stock over time. Trend lines will often form downward and upward peaks, and when this occurs, the higher part of the line represents resistance, while the lower part of the line indicates support.
Taken together, sophisticated traders can use the picture created by support and demand in trend lines to create support resistance indicators, then use those indicators to formulate strategic entrance and exit prices for their trades. Their confidence in the pictures they create generally tends to increase as trading volume goes up, because this makes it theoretically harder to drive the price of a given stock higher or lower.
In going beyond the basics, it’s important to understand that neither support or resistance are fixed concepts. For example, support tends to form when profit-making takes place with a given stock, or when market conditions turn especially uncertain. This creates a kind of plateau effect, which is also known as a short-term top.
And if a given market is especially volatile, support and resistance can temporarily change places, making trading more difficult because future pricing becomes harder to predict.
To minimize the effects of these kinds of variations, some traders prefer a more flexible use of support and resistance. Rather than designate a specific price point, they prefer to establish a support level and a support zone, where prices move within a range of values and an average can be established. This helps them establish a valid trading range that makes their analysis more accurate.
As useful as support and resistance can be to sophisticated, experienced traders, they can be just as damaging to novices. One typical novice mistake is to rely on round numbers too much, using them ineffectively as markers to initiate trades.
There are other common errors as well. The edict to buy at support and sell at resistance is the common-sense equivalent of “buy low, sell high,” but many novices end up doing the opposite because of an incomplete understanding of the concepts and how they work. This is why its important to know as much as possible about support and resistance and integrate that knowledge into your trading strategy to get the best possible results.