Support and Resistance
Fine support and resistance on a chart
Support and resistance identify areas of supply and demand. But what exactly is supply and demand?
Supply is an area on a chart where sellers are likely going to overwhelm buyers causing the stock to go down. On a chart, we call this resistance.
Demand is an area on a chart where buyers are likely going to overwhelm sellers causing the stock to go up. On a chart, we call this support.
Knowing this, it only makes sense to buy at support and sell at resistance!
Stocks run into resistance (supply) because those traders that bought too late and saw the price go down now want to get out at break even so they sell. Stocks find support (demand) because those traders that missed the move up now have a second chance to get in so they buy.
The picture below shows support and resistance and the laws of supply and demand.
Support can become resistance and resistance can become support if prices break through these areas. Here is an example:
In the picture above you can see that once prices fell through support (1) it became resistance (2) and once prices broke through resistance (3) it became support (4).
Ok, you probably already knew all that but here is something that most traders do not know. There are varying degrees of support and resistance.
On the long side, when a stock falls down to a prior low it is more significant than when a stock falls down to a prior high.
On the short side, when a stock rises up to a prior high it is more significant that when a stocks rises up to a prior low.
In other words, the more times a support or resistance area is "hit", the more significant it is. In the first picture above, the support and resistance areas are very significant, whereas in the second picture these areas are only somewhat significant.
Enough rambling, let’s look at some charts...
The chart above shows how stocks run into resistance. But look at the areas that I highlighted in yellow. What are these traders doing buying stocks that are running up into an area of supply (resistance)?
Now, look at the chart below:
The chart above shows how stocks find support. But look at the areas that I highlighted in yellow. What are these traders doing selling stocks that are going down into an area of demand (support)?
They do that because they are novice traders. They always buy after significant buying has already taken place into areas of resistance, and they always sell after significant selling has already taken place into areas of support. YOUR JOB AS A SWING TRADER IS TO IDENTIFY THE NOVICE TRADERS BECAUSE THOSE TRADERS ARE THE ONES YOU WILL PROFIT FROM.
But wait! There are other forms of support and resistance that are not so common. For example, look for stocks that pull back and find support halfway into a prior wide range candle. Like this:
Or, look for stocks to pull back and find support halfway into a gap...
The bottom line is that you want to be buying stocks where buyers will likely come into the stock. You want to be selling stocks where sellers will likely come into the stock. Don't follow the novice traders!
