When technical analysts talk about support and resistance, they are usually referring to “lines of support and resistance,” but, as is presented further on, support and resistance can also be found at high and low points, in moving averages, and in round numbers. Support and resistance are also linked to another phrase: breakouts and breakdowns.
- A sharp drop in price can be a support breakdown
- A sharp rise in price can be a resistance breakout
Areas of Support and Resistance
In the early 20th century, many stock traders began to acknowledge that a stock needs to break out from, or break down “even the smallest resistance” in order for it to be traded. In those days, traders were not assisted by charts or other technical tools, and only used support and resistance. They remembered and wrote down the highs and lows, and related to them as points of future support and resistance. Even traders on the NYSE trading floor, who in the past had traded using hand signals, did not use any kind of chart. Instead, they used areas of support and resistance. These traders can hardly be suspected of unprofessionalism.
Identifying areas of support and resistance in a stock, then, is vital to traders when analyzing the trend and determining their entry and exit points. As already noted, professional traders are always interested in knowing the balance of power between buyers and sellers, and these areas indicate turning points in the balance.
What we Mean by “Support and Resistance”
- The area of support is the price where the stock stops on its way down: in other words, the point at which buyers outnumber sellers.
- The area of resistance is the price where the stock has stopped on its way up. In other words, the point at which sellers outnumber buyers.
In the support area, the majority think that the stock’s price is cheap.
In the resistance area, the majority feel that the stock’s price is expensive.
Professional traders seek to buy a stock on the way up after it breaks through the area of resistance, and will seek to short (sell) when a stock breaks through the area of support.
I want to emphasize that these are areas, not lines, of support and resistance. The term “line” represents a rigid, unfeasible reality. Is it reasonable that all people active in the market will constantly buy at the same support price and always sell at the same resistance price? Of course not. This is even truer for a large market. Additionally, as noted, the principles of technical analysis are known to all people active in the market, and frequently, “lines” will be broken out purposely in order to execute automatic buy and sell orders fed into computers, or to tempt innocent traders into buying and selling a stock.
When Support Turns into Resistance, and Vice Versa
- When an area of resistance breaks out, it turns into an area of support.
- When an area of support breaks down, it turns into an area of resistance.
Let’s examine this rule using the following charts and try to understand how the rule operates:
Resistance – Turning into Support
Resistance becomes support for three reasons:
- Traders like buying stocks that break out through resistance. When a stock breaks out through resistance , they buy it, hoping it will go up. When, to their joy, it rises, creating a new high , they're sorry they didn’t buy a larger quantity at the outset. Now the stock is too expensive to make it worth buying more, but they would love to increase the amount they hold if the stock price would drop to its breakout figure . When it does, they buy, establishing support .
- Other traders who missed the breakout see that the stock is rising, and are sorry they missed the festivities. They won't buy the stock at its peak  because it is too costly, but they're happy to buy it when it returns to the breakout price . When it does, they buy. Buying indicates that they support that price. In other words, they establish support .
- The last ones in on the support list are the “short sellers,” who hoped that the stock would not rise, but were caught with a stock that hit new highs  and were sorry they did not close the shorts before the breakout. They lose money, but psychologically, they have trouble admitting their error and closing the short all the way to the high . Of course, they would be delighted if they were given a chance to exit their short position at the pre-breakout price. That is, buy at that price (we will explain later how a short is closed by buying). When the stock does drop down, they will wipe the sweat from their brow, buy, and also be among those establishing  support.
If a stock drops back down to its “retest” point , then all the traders have a common interest: to buy. This shared interest is what turns resistance into support.
Support – Turning into Resistance
Why does support turn into resistance? For the exact reverse reasons to those detailed above:
- Traders love to sell short stocks that break down through support. When a stock breaks down through support , they execute a short. That is, they sell the stock (more on this later) and hope that it will go down. When, to their joy, it does, and reaches a new low , they’re sorry they didn’t short at the outset with a greater quantity. But now, it has gone down too low for traders to sell another amount. That said, they’d be happy to increase the amount of their short if the price returns to its breakdown point . If it does return, they will increase the quantity of shorts – that is, sell more, and be among those creating resistance .
- Other traders who missed the breakdown  see that the stock is dropping and are sorry they didn’t join the shorting festivities. They won't execute a short when the price is at its lowest  because it has already “dropped down too much,” but they would be happy to execute a short (i.e. to sell) if the price returns to its breakdown point . If it does go back up, they will short and be among those establishing resistance .
- The last group establishing resistance is the “long traders” (in contrast to “short traders”). Long traders are those who believed in the stock and bought it before its breakdown, believing it would go up. Long traders are currently caught with a losing stock: they watch it reach a new low and are sorry they didn’t sell it before the breakdown. They are sustaining large losses and have difficulty in admitting their mistake and selling when the stock price is low . They pray that it will go back up to its breakdown point  when they will happily sell. When it does, they will also be among the sellers establishing resistance .
If a stock rises to its retest point , it will usually encounter resistance originating in the common interest of all those operating in the market at the time: sellers. This shared interest turns support into resistance.
To learn more about the stock market and to begin your own journey toward financial independence, visit Meir Barak's site Tradenet and check out his book "The Market Whisperer."
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