Thursday, July 26, 2007

Lesson 7:Support And Resistance

Technical Analysis: Support And Resistance

Once you understand the concept of a trend, the next major concept is that of support and resistance.

Technical analysts often talk about the ongoing battle between the bulls and the bears, or the struggle between buyers (demand) and sellers (supply). This is revealed by the prices a security seldom moves above (resistance) or below (support).

Support and resistance levels are the levels at which a lot of traders are willing to buy the stock (in the case of a support) or sell it (in the case of resistance).

When these trendlines are broken, the supply and demand and the psychology behind the stock's movements is thought to have shifted, in which case new levels of support and resistance will likely be established.


Round numbers like 10, 20, 35, 50, 100 and 1,000 tend be important in support and resistance levels because they often represent the major psychological turning points at which many traders will make buy or sell decisions.


Role Reversal

Once a resistance or support level is broken, its role is reversed. If the price falls below a support level, that level will become resistance. If the price rises above a resistance level, it will often become support. As the price moves past a level of support or resistance, it is thought that supply and demand has shifted, causing the breached level to reverse its role.

For a true reversal to occur, however, it is important that the price make a strong move through either the support or resistance with good no.of volumes.


In almost every case, a stock will have both a level of support and a level of resistance and will trade in this range as it bounces between these levels. This is most often seen when a stock is trading in a generally sideways manner as the price moves through successive peaks and troughs, testing resistance and support.


The Importance of Support and Resistance
Support and resistance are important part of trend because it can be used to make trading decisions and identify when a trend is reversing.

For example, if a trader identifies an important level of resistance that has been tested several times but never broken, he/she may decide to take profits as the security moves toward this point because it is unlikely that it will move past this level.

As long as the price of the share remains between these levels of support and resistance, the trend is likely to continue. It is important to note, however, that a break beyond a level of support or resistance does not always have to be a reversal.

For example, if prices moved above the resistance levels of an upward trending channel, the trend has accelerated, not reversed. This means that the price appreciation is expected to be faster than it was in the channel.

Traders should avoid placing orders at support and resistance points, as the area around them is usually marked by a lot of volatility.

It is important that you follow this simple rule: do not place orders directly at the support or resistance level. This is because in many cases, the price never actually reaches the whole number, but flirts with it instead.

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