Another basic principle of trading / investing is support and resistance. These are prices where demand and supply meet, i.e…
- When the stock’s price is prevented from rising further, this means that the buying force is checked by the selling force. At that price, there are more sellers than buyers. (Resistance)
- When the stock’s price is prevented from dropping further, this means that the selling force is checked by the buying force. At that price, there are more buyers than sellers. (Support)
Of course, resistance and support levels are not definite as you can see from charts. It’s common to see stocks breaking up through resistance and breaking down through support.
However, this doesn’t mean that you shouldn’t be concerned with them. For example, looking at the attached chart, Biosensors has a strong resistance at $0.99. This can be determined because of the stock has bounced back from $0.99 multiple times (R1, R2, R3).
Therefore, if Biosensors’ stock price were to rise to its resistance of $0.99, you shouldn’t be considering buying it UNTIL it shows buying strength that allows it to break through the resistance at $0.99 convincingly (R4). We know that there’s a convincing breakthrough when we see the price rise above $0.99 with increased volume, as can be seen at point R4.
From the chart, you can see that support and resistance are formed when the price has touched that price level and bounced off. Stronger support and resistance levels are formed at previous highs / lows. For example, take a look at support: S1, S2, S3 and resistance: R1, R2, R3. You know that these are strong levels because they are all formed at previous lows (for support) and previous highs (for resistance).
In between there are still intermediate support and resistance levels, but these are much weaker and serve more for short-term trading. The dashed orange line in the middle of the chart shows an example of an intermediate support/resistance level.
Support and resistance become self fulfilling prophecies as many traders and investors monitor these important price levels and buy or sell based on the action of the stock’s price as it reaches support and resistance.
Category: Charting Indicators