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CHAPTER 5 - Support and Resistance

1) Previous highs and lows, round numbers, trendlines, and moving averages can represent potential support and resistance zones. The more times a price bounces off a particular level, the more significant it becomes as support or resistance. 2) Support can reverse its role to resistance on the way up, and resistance can reverse to support on the way down. 3) The significance of a support or resistance zone depends on the amount of trading activity that occurred there previously and the speed and extent of the prior price move. Zones with more volume and from larger prior moves tend to be more important levels.

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15 views25 pages

CHAPTER 5 - Support and Resistance

1) Previous highs and lows, round numbers, trendlines, and moving averages can represent potential support and resistance zones. The more times a price bounces off a particular level, the more significant it becomes as support or resistance. 2) Support can reverse its role to resistance on the way up, and resistance can reverse to support on the way down. 3) The significance of a support or resistance zone depends on the amount of trading activity that occurred there previously and the speed and extent of the prior price move. Zones with more volume and from larger prior moves tend to be more important levels.

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Natasha Ghazali
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CHAPTER 5: HOW TO

IDENTIFY SUPPORT &


RESISTANCE ZONES
SUPPORT RESISTANCE

• In their classic book Technical Analysis of Stock Trends, Edwards and Magee defined

support as “buying (actual or potential) sufficient in volume to halt a downtrend in

prices for an appreciable period,” and resistance as “selling(actual or potential)

sufficient in volume to satisfy all bids and hence stop prices from going higher for a

time.”
• A support zone represents a concentration of demand, whereas resistance represents a
concentration of supply.

• The word concentration is emphasized because supply and demand are always in balance.
However, it is the relative enthusiasm of buyers as compared to sellers, or vice versa, that is
important because that is what determines trends.

• If buyers are more enthusiastic than sellers, they will continually increase their bids until their
purchasing demands have been satisfied.

• On the other hand, if sellers are the more anxious, then they will be willing to liquidate at
lower

• prices and the general price level will fall. If in doubt, think of support as a temporary floor
for prices and resistance as a ceiling.
• At the beginning of Figure 5.1, the price is declining. It finds a bottom at A and then moves up. The
next time it falls to A, it again rallies, so A may now be said to be a support area.

• The third time the price slips to A, it goes through or, as we say, it violates support. One of the first
principles of identifying a potential support level, then, is to look for previous lows. In the case of
potential resistance, this would be in the area of a previous high.
MAJOR TECHNICAL PRINCIPAL

1) Major Technical Principal A previous high or low is a potential


resistance/support level.
• Figure 5.2 shows a more extended example. This time, the price found temporary support at B.

C also proves to be a support point, but note that the rallies are reversed at support level B.

Thus, the second principle is:


2) Major Technical Principal Support reverses its role to

resistance on the way up.


• Finally, in Figure 5.3, we see the price rally through resistance at B and A (the

former support level). The ensuing decline then finds support at A again.

Thus, our third principle is:

3) Major Technical Principle Resistance reverses its role to support on the way

down.
RULES FOR DETERMINING POTENTIAL
SUPPORT/RESISTANCE POINTS
Previous Highs and Lows

• We have already established that previous highs and lows are potential support or resistance
levels. Highs are important because many market participants may have bought close to or at the
actual high for a move.

• When prices decline, the normal human response is not to take a loss, but to hold on. That way,
the pain of actually realizing a loss can be avoided.

• As a result, when the price returns to the old high, those who bought at that level have great
motivation to sell in order to break even.
• Chart 5.1 shows the sugar price for a period spanning 2002–2003.

• Note how previous highs and lows offer good support/resistance points for
future trading. Unfortunately, there is no way of knowing whether a particular
level will turn out to be support or resistance, or even whether it will be a
pivotal point at all.

• That’s why these are merely intelligent places for anticipating a temporary
reversal. Resort to other indicators such as oscillators is therefore required.
At Round Numbers
• Support and resistance zones have a habit of forming at round numbers.
• This is probably because numbers such as 10, 50, or 100 represent easy psychological points
upon which traders and investors often base their decisions.
• In the 1970s, for example, the Dow Jones Industrials had a great deal of difficulty surpassing
the 1,000 level. For gold in the 1980s and mid-1990s, the magic number was $400, and so
forth.
• The guide for potential turning points, then, is to look for round numbers.

Trendlines and Moving Averages Represent Dynamic Levels of Support and Resistance
• Chart 5.2 shows a very good example of how a down trendline acted as resistance for
Hewlett-Packard.
Emotional Points on a Chart Represent Potential
Support/Resistance Levels
• In Chart 5.3, probably because of unexpected bad news, the sugar price experiences three
downside gaps.
RULES FOR DETERMINING THE PROBABLE
SIGNIFICANCE OF A POTENTIAL SUPPORT OR
RESISTANCE ZONE

• At this point, you are probably asking, “How do I know how important each
support and resistance level is likely to be?” Unfortunately, there is no hard-
and-fast answer, but there are some general rules that can act as guidelines.
• The Amount of a Security that Changed Hands in a Specific Area—the Greater the
Activity, the More Significant the Zone
• The Greater the Speed and Extent of the Previous Move, the More Significant a
Support or Resistance Zone Is Likely to Be
THE END…

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