Typically, we can assume that only a handful of winning positions are going to generate the majority of your profits. There are certain lucrative trades that are naturally going to be home runs, and you should ride these for as long as possible. At the same time, you want to ensure an appropriate level of discipline in your decision making, preventing you from lingering unnecessarily in a losing position. To ensure the very best exit strategy, you can manage your trailing stops point by point, according to the level of technical support garnered by your position.

Levels of Support
A tight stop would be used with solid support, perhaps a two-point trailing stop, which could be loosened if your position continues to remain profitable over a longer period.

Support and resistance lines are your key indicators and any widely-available technical charting software allows you to plot (and refine) both these lines on any security's chart. Both support and resistance should be viewed, not in terms of finite points on the chart, but in terms of ranges of values.

If your security has declined sufficiently to reach a level somewhere within your range of support, you are probably well served to adopt a looser trailing stop as significant strength may very well be evident in your position. By contrast, once your position is entering your zone of resistance, you would be well served to tighten your stops as much as is practical.

Considering Volume
Trading on the basis of support and resistance levels naturally must incorporate volume, because any security will only break through its level of support and resistance if sufficient volume is attached to it. Light volume may cause support or resistance trends only to pause while sufficient volume will cause such trends to reverse.

Indeed, the concepts of support and resistance are based on reversals, where a trend will reverse on its upper end when it reaches resistance; and the trend will reverse on its bottom when it hits its range of support.

The Psychology of Support and Resistance
Support and resistance levels exist only by virtue of traders' and investors' memories of their experiences with trading a given security at certain levels in the past. Investors will be more inclined to lend their support at the same level at which a large crowd of investors once purchased the stock. Traders tend to have the expectation that a stock will rise again from the same level as it did in the past. Even if those traders did not hold the security in a previous session, they will still look to history to be their guide, examining prior examples of session bottoms and levels of support.

You should also note that particular zones of support or resistance are expected to shift to their opposite once their zones have been breached. For example, a strong zone of resistance, once breached, becomes a psychological victory for traders and quickly turns into a zone of support for the ensuing trend as traders continue to celebrate the victorious breakout. By contrast, once a zone of support is destroyed, the psychological deflation is all too real, as the chart stubbornly refuses to touch this zone again in the near future.

The psychology of support and resistance corresponds to the vicious emotions of pain and regret. Traders holding losing positions feel pain and, looking for the first available opportunity to lessen their pain, abandon their positions. Traders who missed a good opportunity tend to feel regret and look to trends from the past to find new opportunities to make up for missed chances in the past.

Even in a flat market, these emotions can be prevalent. Traders may practice buying at the lower edge of a range and shorting at the upper edge. In uptrends, bears who engage in short selling will naturally feel pain, and bulls will experience regret that they did not buy more. Both will be eager to buy, if and when the market gives them a second chance, which will create support during investors' reactions in an uptrend.

Resistance indicates bulls feeling pain, bears feeling regret and both camps ready and waiting to sell. A downward breakout from a trading range will cause pain to bulls who bought, and will make them eager to sell during the first market rally so that they can get out even. Bears will regret not shorting more and wait for that same rally to allow for a second chance to sell short. The pain of bulls and the regret of bears in a downtrend translate into what is referred to as resistance.

The Bottom Line
Support and resistance ranges are key concepts that will sharply refine your exit decisions to a fine point. At first glance, the imprecise nature of ranges may appear to be a detriment to precision, but your trailing stops will ensure some compensation for this potential problem. Always use trailing stops when exiting a position and always be sure to revise them according to the desired tightness or looseness of your exit strategy.

Related Articles
  1. Trading Strategies

    Momentum And The Relative Strength Index

    These two indicators can give the trader a better understanding of when to get in and out of an issue.
  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. Options & Futures

    Vertical Bull and Bear Credit Spreads

    This trading strategy is an excellent limited-risk strategy that can be used with equity as well as commodity and futures options.
  4. Active Trading Fundamentals

    Short Selling Risk Can Be Similar To Buying Long

    If more people understood short selling, it would invoke less fear, which could lead to a more balanced market.
  5. Chart Advisor

    These Oil & Gas Stocks Have Reversed

    It's been a long downtrend for oil stock owners, but there's hope. These four oil and gas stocks have reversed and may keep trending to the upside.
  6. Stock Analysis

    The Biggest Risks of Investing in Netflix Stock

    Examine the current state of Netflix Inc., and learn about three of the major fundamental risks that the company is currently facing.
  7. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  8. Professionals

    Top Stocks to Short, Go Long On to Beat the Market

    A long/short portfolio can help weather a variety of market scenarios. Here's how to put one together.
  9. Mutual Funds & ETFs

    Top 3 Muni California Mutual Funds

    Discover analyses of the top three California municipal bond mutual funds, and learn about their characteristics, historical performance and suitability.
  10. Chart Advisor

    4 European Stocks to Consider Buying

    European companies, listed on US exchanges, that are providing buying opportunities right now.
  1. What is an optimal trading strategy to take after a trader spots a bullish abandoned ...

    The bullish abandoned baby candlestick pattern is a highly reliable reversal signal, though it may be difficult to spot as ... Read Full Answer >>
  2. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  3. Can your car insurance company check your driving record?

    While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
  4. How do mutual funds split?

    Mutual funds split in the same way that individual stocks split, but less often. Like a stock split, mutual fund splits do ... Read Full Answer >>
  5. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  6. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  2. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  3. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  4. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  5. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  6. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
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!