One of the most common technical analysis tools is using support and resistance lines. The concept of this is pretty easy to understand, but in practice, is a little bit more complicated than that. In this blog post, we’ll break down what they are, different methods for plotting the lines, and a few important factors to keep in mind.
What are Support and Resistance Lines?
Two of the most common technical analysis terms, support and resistance lines use chart patterns and price levels to determine where a downward or upward trend will likely end.
To put it in plain English, support is a price level where a stock price has dropped to, but hasn’t dropped lower. Resistance is the reverse, where a price level of a stock has risen to, but hasn’t broken above. When a stock goes above support or resistance levels, it could be a true breakout, or a false breakout.
Traders can find these lines by identifying what price levels a stock consistently reverses an uptrend or downtrend. Some traders use this to find entry and exit points to their trades.
While common in analysis, support and resistance isn’t necessarily simple. What may look like one of these lines may actually be the random or chaotic nature of the markets. So while these lines are pretty easy to grasp, they require a little more effort to implement in your analysis. Humans often try to look for patterns, but with the markets, it may be more random.
Read More: Beginner’s Guide to Technical Analysis
How do I Determine Support and Resistance Lines?
There are a few different ways to identify areas of support and resistance, including trendlines, and moving averages.
Trendlines can show a consistent price level that a stock rarely breaks out of, and is a popular method of finding support and resistance. However, if a stock breaks out of the trendline, a new level is formed. Additionally, a stock that breaks out of the trendline may only do that for a short time, before returning to its “regular” trendlines.
Investopedia writes that something else to consider is that “…an asset’s price may have a difficult time moving beyond a round number, such as $50 or $100 per share.”
There are two main reasons for this:
- Newer traders usually buy and sell at whole numbers
- Target prices and stop orders by retail investors and investment banks are usually at round numbers.
A technical indicator many traders use, moving averages smooth out past prices and can help you find areas of support and resistance. This happens when the moving averages appear to form a support line on an uptrend, and resistance line as a downtrend. You can try different moving averages to see which works best for you.
Factors to Consider for Support and Resistance
When looking for a support/resistance line, you’ll want to take into account the number of times the stock’s price hits that line. The more times the price hits that line, the more significant the line is.
The higher the volume, the more buying and selling that occurs, the stronger the resistance and support lines will likely be. Additionally, the longer the lines have occurred, the more significant they are.
Support and resistance lines are a very popular analysis method for trading. While the concept is straightforward, putting into practice requires a little more work. Don’t forget—technical analysis is just what it says in the name, analysis. It is up for interpretation, and different people may see things differently.
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