Understanding basic support and resistence levels
Support and resistence levels are one of the most commonly discussed features of the stock market and for technical analysts, establishing the current support and resistence levels is an ongoing task. A support level is a price which the market thinks a stock will struggle to fall below. A resistence level is a price which it will struggle to rise above.
The most common resistence levels are the prices at which a previous advance was halted, the previous high. The most common support levels are those prices at which previous declines were reversed, the previous low. The reason that these levels provide support and resistence is mainly due to plain old human psychology. When a rising price approaches the level at which it started to fall last time, human nature makes people wonder if it will fall again. Many people who bought close to that level the last time round, sell in order to break even rather than risk another fall. This extra selling pressure can push the price back down.
The same is true of a falling price; as it approaches it’s previous low, poeple who short sold the stock buy it back for fear of the reversal repeating itself.
Once this hasreversal has repeated itself once, the next time the price rises towards the resistence level (or falls to the support level) human nature makes people think it even more likely that it will reverse because it’s done so twice before. This means that (at a resistence level) people sell again and the price falls for a third time. The more and more times a resistence or support level fails to be broken the more significant it becomes in peoples minds, making it more likely that it will hold next time.
However if a resistence (or support line) is broken, then prices have a tendency to rise (or fall dramtically, this is why they are considered so important. When a resistence line is broken people often buy into the stock feeling that there is now nothing to stop the advance, similarly when a support line is breached heavy selling occurs out of fear as to how far the stock might fall.
The other key feature of support and resistence lines is that they tend to reverse roles. When a resistence line is broken it often then becomes a support line for the new higher price. Similarly when a support level is breached it becomes a resistence level for the new lower trading range. This can be seen perfectly on this chart for US stock Haliburton;
The final point to note is that there can be many pshychologicaly important price levels because of the many charting patterns and price movements which people have observed inthe past. This is why you often here analysts say things like “if it crosses 10,024 it could go to 10,086″ (for example), meaning tnat they believe there are two resistence levels and if the first is broken, the price could rise quickly until it meets the second.
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