The subject of support and resistance is a complex topic, with many different concepts, and many different interpretations of these concepts. For instance, there are several different ways to draw a trendline - it's as much an art as it is science. One concept that is often misunderstood by beginning traders is that support and resistance is not a precise area. In fact, support and resistance tends to encompass a larger area. So, while a trendline or moving average may look precise on a chart, in the real world, there are several factors that can contribute to price overshooting these areas. Following this concept, support and resistance areas can also be thought of as rubber bands; they will often bend, as stops get filled or momentum traders jump in early, before snapping back.
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One important concept to be aware of is that support and resistance can be defined in many ways, such as prior pivot highs or lows, moving averages, or trendlines. The important factor for a trader to be cognizant of is what area is proving to have importance to the trend of a stock. It is in these areas that a trader can then look for reversal or continuation patterns on which to base their trade ideas. (To learn more about this concept, be sure to read the Support And Resistance section of our Technical Analysis Tutorial.)
For instance, the chart for Boeing (NYSE:BA) is showing an area that cleanly divides the recent trading action. While more precise trendlines could be drawn on the chart, it is apparent that the $38 area was a support level that is now acting as a resistance level. The higher the volume, the more importance the area usually takes as it shows increased participation from traders.
Caterpillar (NYSE:CAT) is another example of a chart showing a larger support/resistance level. This is a good example of a situation in which a horizontal trendline could be misleading in defining resistance, as price has overshot it a few times. While CAT has rallied sharply over the past few weeks, it was clear that it would have a difficult time surpassing the resistance zone, particularly while it was overbought, as measured by the slow stochastics indicator.
3M Company (NYSE:MMM) has a chart that is very similar to CAT. It was holding above the $53 area before breaking down in February. That area should act as resistance moving forward, and stopped the rally in its tracks a few days ago. A move above this area would be quite bullish, but probably unlikely in the near future. Notice how the 50-day and 200-day moving averages are sloping downward, and slow stochastics is showing overbought readings. MMM would likely need to trade sideways for a while to build up enough energy for a serious rally attempt.
Pfizer (NYSE:PFE) is a great example of support and resistance taking many forms. Notice how the $14.50 has proved important over the past few months. It held the down thrust in late November, and then acted as a level of congestion in February. It then acted as a resistance level in March, containing the recent rally. Also notice how it coincided with a declining 50-day moving average. Often a confluence of support and resistance levels will positively reinforce those areas, increasing a trader's odds for a successful trade.
Support and resistance levels are often not precisely defined, yet they can remain perfectly clear on a chart. Each of the stocks above has a similar chart, and each is currently trading under a resistance level that can be better defined as a zone. What is interesting to note is that each of these is a component of the Dow Jones Industrial Average (DJIA). The DJIA is also showing a similar pattern of trading under a larger resistance area. While the recent rally has been impressive, the resistance area above would need to give way for the charts to really start looking more bullish. (Be sure to read Retracement Or Reversal: Know The Difference to help you learn to distinguish between a temporary price change and a long-term trend.)
Do you think these charts will continue heading lower, or are they getting ready to clear their resistance zones? Let us know what you think by joining the Investopedia Community.
At the time of writing, Joey Fundora did not hold a position in any of the companies mentioned above.