The concepts of support and resistance are undoubtedly two of the most highly discussed attributes of technical analysis and they are often regarded as a subject that is complex by those who are just learning to trade. This article will attempt to clarify the complexity surrounding these concepts by focusing on the basics of what traders need to know. You'll learn that these terms are used by traders to refer to price levels on charts that tend to act as barriers from preventing the price of an asset from getting pushed in a certain direction.

At first the explanation and idea behind identifying these levels seems easy, but as you'll find out, support and resistance can come in various forms and it is much more difficult to master than it first appears.

The Basics
Most experienced traders will be able to tell many stories about how certain price levels tend to prevent traders from pushing the price of an underlying asset in a certain direction. For example, assume that Jim was holding a position in Amazon.com (AMZN) stock between March and November 2006 and that he was expecting the value of the shares to increase. Let's imagine that Jim notices that the price fails to get above $39 several times over the past several months, even though it has gotten very close to moving above it. In this case, traders would call the price level near $39 a level of resistance. As you can see from the chart below, resistance levels are also regarded as a ceiling because these price levels prevent the market from moving prices upward.

Figure 1

On the other side of the coin, we have price levels that are known as support. This terminology refers to prices on a chart that tend to act as a floor by preventing the price of an asset from being pushed downward. As you can see from the chart below, the ability to identify a level of support can also coincide with a good buying opportunity because this is generally the area where market participants see good value and start to push prices higher again.

Figure 2

Trendlines
In the examples above, you've seen a constant level prevent an asset's price from moving higher or lower. This static barrier is one of the most popular forms of support/resistance, but the price of financial assets generally trends upward or downward so it is not uncommon to see these price barriers change over time. This is why understanding the concepts of trending and trendlines is important when learning about support and resistance. When the market is trending to the upside, resistance levels are formed as the price action slows and starts to pull back toward the trendline. This occurs as a result of profit taking or near-term uncertainty for a particular issue or sector. The resulting price action undergoes a "plateau" effect or slight drop-off in stock price, creating a short-term top.

Many traders will pay close attention to the price of a security as it falls toward the broader support of the trendline because historically, this has been an area that has prevented the price of the asset from moving substantially lower. For example, as you can see from the Newmont Mining Corp (NEM) chart below, a trendline can provide support for an asset for several years. In this case, notice how the trendline propped up the price of Newmont's shares for an extended period of time.

Figure 3

On the other hand, when the market is trending to the downside, traders will watch for a series of declining peaks and will attempt to connect these peaks together with a trendline. When the price approaches the trendline, most traders will watch for the asset to encounter selling pressure and may consider entering a short position because this is an area that has pushed the price downward in the past.

The support/resistance of an identified level, whether discovered with a trendline or through any other method, is deemed to be stronger the more times that the price has historically been unable to move beyond it. Many technical traders will use their identified support and resistance levels to choose strategic entry/exit prices because these areas often represent the prices that are the most influential to an asset's direction. Most traders are confident at these levels in the underlying value of the asset so the volume generally increases more than usual, making it much more difficult for traders to continue driving the price higher or lower.

Round Numbers
Another common characteristic of support/resistance is that an asset's price may have a difficult time moving beyond a round price level such as $50. Most inexperienced traders tend to buy/sell assets when the price is at a whole number because they are more likely to feel that a stock is fairly valued at such levels. Most target prices/stop orders set by either retail investors or large investment banks are placed at round price levels rather than at prices such as $50.06. Because so many orders are placed at the same level, these round numbers tend to act as strong price barriers. If all the clients of an investment bank put in sell orders at a suggested target of, for example, $55, it would take an extreme number of purchases to absorb these sales and, therefore, a level of resistance would be created.

Moving Averages
Most technical traders incorporate the power of various technical indicators, such as moving averages, to aid in predicting future short-term momentum, but these traders never fully realize the ability these tools have for identifying levels of support and resistance. As you can see from the chart below, a moving average is a constantly changing line that smooths out past price data while also allowing the trader to identify support and resistance. Notice how the price of the asset finds support at the moving average when the trend is up, and how it acts as resistance when the trend is down. Most traders will experiment with different time periods in their moving averages so that they can find the one that works best for this specific task.

Figure 4

Other Indicators
In technical analysis, many indicators have been developed to identify barriers to future price action. These indicators seem complicated at first and it often takes practice and experience to use them effectively. Regardless of an indicator's complexity, however, the interpretation of the identified barrier should be consistent to those achieved through simpler methods.

For example, the Fibonacci retracement tool is a favorite among many short-term traders because it clearly identifies levels of potential support/resistance. The reasoning behind how this indicator calculates the various levels of support and resistance is beyond the scope of this article, but notice in Figure 5 how the identified levels (dotted lines) are barriers to the short-term direction of the price.

Figure 5

The Bottom Line
Determining future levels of support can drastically improve the returns of a short-term investing strategy because it gives traders an accurate picture of what price levels should prop up the price of a given security in the event of a correction. Conversely, foreseeing a level of resistance can be advantageous because this is a price level that could potentially harm a long position because it signifies an area where investors have a high willingness to sell the security. As mentioned above, there are several different methods to choose when looking to identify support/resistance, but regardless of the method, the interpretation remains the same - it prevents the price of an underlying from moving in a certain direction.

Related Articles
  1. Mutual Funds & ETFs

    It Might Be Too Late for Inverse Oil ETFs

    Learn why investors seeking to short the price of oil may want to be careful when using leveraged ETFs, and see how oil prices may have reached a bottom.
  2. Active Trading Fundamentals

    The Psychology Of Support And Resistance Zones

    Emotion drives the market more than you might realize. Find out how psychology affects support and resistance zones.
  3. Technical Indicators

    Interpreting Support And Resistance Zones

    Use of support and resistance zones can be a key to successful trades. Learn how they work and how to use them.
  4. Active Trading Fundamentals

    Support And Resistance Reversals

    Discover how these influential levels can switch roles.
  5. Technical Indicators

    Use Volume And Emotion To Tackle Topping Patterns

    Selling short in a topping pattern offers an advantageous reward-to-risk profile, but it can be hard to find good entry prices.
  6. Charts & Patterns

    New Approaches To The Old Cup And Handle

    Many cup and handle traders adhere strictly to O'Neil’s rules for construction, but there are many variations that produce reliable results.
  7. Trading Strategies

    Do You Have The Right Settings On Your Stochastic?

    Use these helpful tips to unlock Stochastics' full potential.
  8. Trading Strategies

    Trading Volatile Stocks with Technical Indicators

    Short-term traders seek volatility because of the profit potential, which leads to two common questions. How do I find volatile stocks? And how do I use technical indicators to trade them? Find ...
  9. Active Trading

    The Elder-Ray Indicator: Seeing Into The Market

    Elder-ray helps determine the strength of competing groups of bulls and bears so you know when to buy and when to short.
  10. Active Trading Fundamentals

    Confirming Price Movements With Volume Oscillators

    Use this indicator to validate a change in price direction and moving averages.
RELATED TERMS
  1. Accumulation/Distribution

    An indicator that tracks the relationship between volume and ...
  2. Oscillator

    A technical analysis tool that is banded between two extreme ...
RELATED FAQS
  1. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  2. How can a swing trader use a Fibonacci retracement?

    Swing traders can use the Fibonacci retracement to determine levels of support and resistance for a price on a chart, as ... Read Full Answer >>
  3. What are the most popular volume oscillators in technical analysis?

    The most popular volume oscillators in technical analysis are the Percentage Volume Oscillator, or PVO, and the Chaikin Oscillator. ... Read Full Answer >>
  4. How do I implement a forex strategy when spotting a StochRSI pattern?

    The StochRSI indicator is used in forex trading as it is in stock or options trading. Though it is often used to identify ... Read Full Answer >>
  5. How effective is creating trade entries after spotting a Triple Bottom pattern?

    The triple bottom is among the most reliable chart patterns, so creating a trade strategy based on this formation can be ... Read Full Answer >>
  6. What are the best ways to identify Retracements on a stock?

    Technical analysts believe that retracements – temporary movements against a stronger existing price trend – can be distinguished ... Read Full Answer >>
  7. How do I build a profitable strategy when spotting a Stick Sandwich pattern?

    Though the stick sandwich is not the most reliable candlestick pattern, it can still be used to create profitable trade strategy ... Read Full Answer >>
  8. Why is the 50 Simple Moving Average (SMA) so common for traders and analysts?

    The 50-period simple moving average, or SMA, is commonly plotted on charts and utilized by traders and market analysts because ... Read Full Answer >>
  9. How do I build a profitable trading strategy when using Pivots?

    Developed by floor traders as an easy way to gauge market tendency based on the prior session's performance, pivot trading ... Read Full Answer >>
  10. What are the differences between a Pivot and a Pivot Point?

    Pivot trading is a popular strategy among day traders because it is simple and effective. A pivot is simply the point at ... Read Full Answer >>
  11. How effective is creating trade entries after spotting a Morning Star pattern?

    The morning star candlestick pattern is largely consistent in predicting a bullish reversal in a chart with a stable bearish ... Read Full Answer >>
  12. What is a common strategy traders implement when using Moving Average Envelopes?

    Apply a moving average envelope to a price chart by adding upper and lower moving bands a percentage above and below a standard ... Read Full Answer >>
  13. What are the best technical indicators to complement On-Balance Volume (OBV)?

    The concept of confirmation -- whether with a price chart or preferably another technical indicator – should be of paramount ... Read Full Answer >>
  14. What are the best technical indicators to complement the Money Flow?

    The money flow index (MFI) is a momentum indicator that is popular among traders and analysts. Its calculation and interpretation ... Read Full Answer >>
  15. What are the best technical indicators to complement the McClellan Oscillator?

    The types of indicators that most naturally complement the McClellan Oscillator are those that also complement other forms ... Read Full Answer >>
  16. How are Mat Hold patterns interpreted by analysts and traders?

    The mat hold candlestick pattern is a fairly reliable bullish continuation signal, though finding one can be a bit of a challenge. ... Read Full Answer >>
  17. How are Harami Cross patterns interpreted by analysts and traders?

    The harami cross is a common candlestick reversal pattern consisting of two candles, with the second nesting within the range ... Read Full Answer >>
  18. How effective is creating trade entries after spotting a Harami Cross pattern?

    Because this pattern is relatively common, entering a trade following a harami cross can have mixed results. The harami cross ... Read Full Answer >>
  19. Why is the Dual Commodity Channel Index (DCCI) important for traders and analysts?

    The dual commodity channel index (DCCI) is an adaptation of the original commodity channel index (CCI) that was developed ... Read Full Answer >>
  20. What is a common strategy traders implement when using the Exponential Moving Average ...

    A common strategy traders use to exploit the exponential moving average (EMA) indicator is the moving average bounce. In ... Read Full Answer >>
  21. What are the main rules for building a strategy using Andrew's Pitchforks?

    Andrews' pitchfork is a technical indicator, created by Dr Alan H. Andrews, that can be an effective tool in establishing ... Read Full Answer >>
  22. How can the Chikou Span help my trading strategy?

    The Chikou span is part of the multifaceted Ichimoku Kinko Hyo charting strategy. The Ichimoku Kinko Hyo is a technique intended ... Read Full Answer >>
  23. How do traders identify descending triangle patterns?

    Descending triangles are formed with two trendlines drawn on a security or index's price chart, one as a resistance line ... Read Full Answer >>
  24. What are the main trading signals on the Accumulated Swing Index?

    The accumulative swing index uses a scale from zero to 100 for bull movements and zero to -100 for bear movements; subsequently, ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!