Basic Concepts

Support and Resistance

Support and Resistance are foundational concepts of Technical Analysis.

• Support occurs when a downward movement in price is met with a concentration of demand (buyers) obstructing prices from moving lower.
• Resistance occurs when a upward movement in price is met with a concentration of supply (sellers) obstructing price from moving higher.
• Technical analysis uses support and resistance to identify price levels where the probabilities favor a halt or reversal of price movement. 

Identification:

• Price must test a horizontal Support or Resistance line multiple times.

Trading Support and Resistance:

• Support or resistance levels can serve as potential entry or exit points. A trade can be placed based on the belief that support and resistance zones will not be broken. If the price moves in the wrong direction (breaks through prior support or resistance levels), the position can be closed at a small loss. If the price moves in the right direction (respects prior support or resistance levels), however, the move may be substantial.
• If prices are trading in a range, a strategy that places short trades as the price touches the upper trendline and long trades as price reverses to touch the lower trendline is extremely dangerous, and it is much better to wait to see in which direction price will break out of the range and then place your trades in that direction.

Support and Resistance Notes:

• When price does break through Support or Resistance, their roles are often reversed. Support becomes Resistance or Resistance becomes Support.
• Support and Resistance levels exist because traders and investors remember the past and are waiting for a prior level to buy or sell. This can be waiting to enter at a good price or hoping to get out of a losing trade near where they entered.
• The term Support and Resistance Line refers to a horizontal live or level. Support and Resistance also often happens at trendlines and inside channels.
• Many target prices or stop orders set by either retail investors or large investment banks are placed at Round Price Number levels such as $95.00 rather than at prices such as $95.06. Because so many orders are placed at the same level, these round numbers tend to act as strong price barriers.
• Moving Averages often act as Support and Resistance.
• Fibonacci retracement is a favorite tool among many short-term traders used to identify levels of potential support/resistance.
• If there has been strong Volume at a Support or Resistance level in the past, then the Support or Resistance level should be stronger.
• Support and resistance levels in longer time frame charts such as weekly or monthly charts are often more significant than those seen in shorter time frame charts such as the one-minute or five-minute chart.

Trendlines

Trendlines are drawn by connecting peaks (highs) together or by connecting valleys (lows) together.

Many chart patterns such as triangles and wedges are comprised of two trendlines.

Trendlines help determine the trend or direction of the market (up/down or bull/bear). Trendlines may indicate buying and selling opportunities when price crosses them.

Trendline breakouts on weekly chart give more reliable signals than daily.

Logarithmic scale signals trendline pierces earlier than arithmetic scale.

Trendlines may also be usefull for chart pattern trading in setting profit target and/or stop loss prices after chart pattern breakouts, even though the trendline is not part of the chart pattern.

Trend

The trend is your friend

• Short Term: 0 – 3 months
• Mid Term: 3 – 6 months
• Long Term: 6 months or more

Hand drawn trendlines can be used to illustrate a stocks trend.

Often prices zigzag between an upper trendline and a lower trendline clearly showing the up trend or down trend.

For an uptrend draw the trend’s trendline through the lows of the interal such that it does not intersect any prices. A trend change occurs when there is a breakout below the trendline and prices close 20% below the breakout.

For a downtrend draw the trend’s trendline through the highs of the interal such that it does not intersect any prices. A trend change occurs when there is a breakout above the trendline and prices close 20% above the breakout.

To facilitate automated analysis, you can use the linear regression line of prices over the desired interval to represent the trend.

Trend = 100 * slope of linear regression line / last closing price.

This represents the percent change of price per bar over the interval and is a single normalized number for trend that allows comparison between different instruments and that can be used in stock screening filters.