Support & Resistance
Explore the fundamentals of support and resistance levels in stock chart analysis. StockCharts ChartSchool offers you the resources to empower you with the knowledge to navigate the stock market.
Last updated
Was this helpful?
Explore the fundamentals of support and resistance levels in stock chart analysis. StockCharts ChartSchool offers you the resources to empower you with the knowledge to navigate the stock market.
Last updated
Was this helpful?
Support and resistance levels represent key junctures where supply and demand meet. In the financial markets, prices are driven by excesses of supply (down) and demand (up). Supply is synonymous with bearish, bears, and selling. Demand is synonymous with bullish, bulls, and buying. These terms are used interchangeably throughout this and other articles. As demand increases, prices advance, and as supply increases, prices decline. When supply and demand are equal, prices move sideways as bulls and bears slug it out to gain control.
Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.
Support does not always hold, however, and a break below support signals that the bears have won out over the bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive to buy. Support breaks and new lows signal that sellers have reduced their expectations and are willing sell at even lower prices. In addition, buyers could not be coerced into buying until prices declined below support or below the previous low. Once support is broken, another support level will have to be established at a lower level.
Support levels are usually below the current price, but it is not uncommon for a security to trade at or near support. As technical analysis is not an exact science, setting precise support levels can often be difficult. In addition, price movements can be volatile and briefly dip below support. For example, it does not seem logical to consider a support level broken if the price closes an eighth below the established support level. For this reason, some traders and investors establish support zones.
Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. Logic dictates that, as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance.
Resistance does not always hold; a break above resistance signals that the bulls have won out over the bears. A break above resistance shows a new willingness to buy and/or a lack of incentive to sell. Resistance breaks and new highs indicate buyers have increased their expectations and are willing to buy at even higher prices. In addition, sellers could not be coerced into selling until prices rose above resistance or above the previous high. Once resistance is broken, another resistance level will have to be established at a higher level.
Resistance levels are usually above the current price, but it is not uncommon for a security to trade at or near resistance. In addition, price movements can be volatile and rise above resistance briefly. Sometimes it does not seem logical to consider a resistance level broken if the price closes 1/8 above the established resistance level. For this reason, some traders and investors establish resistance zones.
Support and resistance share enough common characteristics to be mirror images of each other.
Support can be established with the previous reaction lows, while resistance can be established by using the previous reaction highs.
The below chart of Halliburton (HAL) shows a large trading range between Dec-99 and Mar-00. Support was established with the October low around 31. In December, the stock returned to support in the mid-thirties and formed a low of around 33. Finally, in February, the stock again returned to the support scene and formed a low of around 32 1/2.
After each bounce off a support level, the stock traded up to resistance. Resistance was first established by the September support break at 42.5. After a support level is broken, it can turn into a resistance level. The stock advanced to the new support-turned-resistance level of around 42.5 from the October lows. The resistance level was confirmed when the stock failed to advance past 42.5. The stock traded up to 42.5 twice after that and failed to surpass resistance.
Another principle of technical analysis stipulates that support can turn into resistance and vice versa. Once the price breaks below a support level, the broken support level can turn into resistance. The break of support signals that the forces of supply have overcome the forces of demand. Therefore, if the price returns to this level, there is likely to be an increase in supply, hence resistance.
The other turn of the coin is resistance turning into support. As the price advances above resistance, it signals changes in supply and demand. The breakout above resistance proves that the forces of demand have overwhelmed the forces of supply; if the price returns to this level, demand will likely increase, and support will be found.
The NASDAQ 100 Index ($NDX) broke resistance at 935 in May-97 and traded just above this resistance level for over a month (see chart below). As the index remained above resistance, 935 was established as a new support level. The stock rose to 1150 but fell back to test support at 935. After the second test of support at 935, this level is well established.
In the chart below, you see that support can turn into resistance and then back into support. PeopleSoft found support at 18 from Oct-98 to Jan-99 (green oval) but broke below support in Mar-99 as the bears overpowered the bulls. When the stock rebounded (red oval), there was still overhead supply at 18, and resistance was met from Jun-99 to Oct-99.
Where does this overhead supply come from? Demand was obviously increasing around 18 from Oct-98 to Mar-99 (green oval). Therefore, there were a lot of bullish buyers of the stock around 18. When the price declined below 18 and fell to around 14, many of these (now unhappy) bulls were probably still holding the stock. This left a supply overhang (commonly known as resistance) around 18. When the stock rebounded to 18, many green-oval-bulls probably took the opportunity to sell and “escape” with little to no loss. When this supply was exhausted, the demand could overpower supply and advance above resistance at 18.
Trading ranges can be important in determining whether support and resistance function as turning points or continuation patterns. A trading range is when prices move within a relatively tight range. This signals that the forces of supply and demand are evenly balanced. When the price breaks out of the trading range, above or below, it signals that a winner has emerged. A break above is a victory for the bulls (demand), and a break below is a victory for the bears (supply).
After an extended advance from 27 to 64, WorldCom (WCOM) entered a trading range between 55 and 63 for about five months. There was a false breakout in mid-June when the stock briefly poked its head above 62 (red oval). This did not last long, and a gap down a few days later nullified the breakout (black arrow). The stock then proceeded to break support at 55 in Aug-99 and trade as low as 50.
The stock bounced off 55 two more times before heading lower (support turning to resistance). While this doesn't always happen, a return to the new resistance level offers a second chance for longs to get out and shorts to enter the fray.
In Nov/Dec-99, Lucent Technologies (LU) formed a trading range that resembled a head and shoulders pattern (red oval). When the stock broke support at 60, there was little or no time to exit. Even though a long black candlestick indicates an open at 59, the stock fell so fast that it was impossible to exit above 44. In hindsight, the support line could have been drawn as an upward-sloping neckline (blue line), and the support break would have come at 61. This is only one point higher; a trader must take action immediately to avoid a sharp fall. However, the lows match up nicely with the neckline, which is something to consider when drawing support lines.
After Lucent declined, a trading range was established between 40.5 and 47.5 for almost two months (green oval). The resistance level of the trading range was well-marked by three reaction peaks at 47.5. The support level was not as clearly marked but is between 40 and 41. Some buying interest began to become evident around 44 in mid-to-late February. Notice the many candlesticks with long lower shadows, or hammers, as they are known. The stock then formed two up gaps on 24-Feb and 25-Feb and finally closed above resistance at 48. This was a clear indication of demand winning out over supply. There were still two more opportunities (days) to get in on the action. On the third day after the breakout, the stock gapped up and moved above 56.
Because technical analysis is not an exact science, creating support and resistance zones is useful. This contradicts the strategy mapped out for Lucent Technologies (LU), but it is sometimes the case.
Each security has its characteristics, and analysis should reflect the intricacies of the security. Sometimes, exact support and resistance levels are best, and sometimes, zones work better. Generally, the tighter the range, the more exact the level. If the trading range spans less than two months and the price range is relatively tight, then more exact support and resistance levels are best suited. If a trading range spans many months and the price range is relatively large, it's best to use support and resistance zones. These are only general guidelines, and each trading range should be judged on its own merits.
Returning to the Halliburton (HAL) analysis, you can see that the November high of the trading range (32 to 44) extended more than 20% past the October low, making the range quite large relative to the price. Because the September support break forms the first resistance level, you're ready to set up a resistance zone after the November high is formed, probably around early December. However, it's difficult to tell if a large trading range will develop.
The subsequent low in December, which was just higher than the October low, offers evidence that a trading range is forming, and we are ready to set the support zone. As long as the stock trades within the boundaries set by the support and resistance zone, we will consider the trading range to be valid. Support may be looked upon as an opportunity to buy, and resistance as an opportunity to sell.
Identification of key support and resistance levels is an essential ingredient to successful technical analysis. Even though it's sometimes difficult to establish exact support and resistance levels, knowing their existence and location can greatly enhance analysis and forecasting abilities. If a security is approaching an important support level, it can serve as an alert to be extra vigilant in looking for signs of increased buying pressure and a potential reversal. If a security approaches a resistance level, it can act as an alert to signs of increased selling pressure and potential reversal. If a support or resistance level is broken, the relationship between supply and demand has changed. A resistance breakout signals that the bulls (demand) have gained the upper hand, and a support break signals that the bears (supply) have won the battle.
