TheStockTalk.net

Ok, so support and resistance. I would say that these are definitely among the top things an investor should know and understand when considering a stock technically. We can define support as a price level at which the stock reaches a price floor and finds buying “support” and resistance as a price ceiling where the stock’s upward move is halted due to selling pressure.

You could look at the two terms in another way as well: 1) when a stock reaches support, if the stock bounces off the support and moves upward, one could conclude that investors viewed the stock as oversold and at a value too low so they buy, and 2) if a stock hits resistance and falls in price, it might be viewed as the stock price reaching a value that is inflated and over bought so the price falls back into the “proper” trading value.

To identify support and resistance let’s take a look at a the graph for GM:

To find the two elements, look for price channels. In other words, find where the stock price stays within a certain range for a certain amount of time. In this chart there are 2 major price channels:

The channels are between the 2 lines. Now to create the lines that identify the channels you just look for several tops that are around the same price and connect the tops. In some cases, like GM, the range doesn’t have a constant, concrete price at which it tops but it has a general area that will do. These lines that are drawn are support and resistance. The stock usually won’t go past either line so it would be an educated opinion to assume that the stock will continue in this pattern. The only thing is that stocks don’t continue in this pattern forever - they breakout!

The breakout is when the price level moves either above the resistance or below the support. There are 2 types of breakouts which consist of false and true breakouts. As you might be guessing, a false breakout is when the stock price moves outside the range but then returns soon there after. True breakouts are considered buy or sell signals based on if it is support or resistance being penetrated respectively. Here is a look at both types of breakouts on the GM chart:

I have circled the false breakout with a red circle and the true breakout with a green circle. I usually give myself a range that the breakout has to penetrate before I trade the stock just to eliminate the false breakout triggers. This method does take away some of the profit and increases some of the loss, but I think it is negligible compared to selling and then having the stock raise just like in the GM graph or buying it and having it sink.