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Support and Resistance

Simply stated, support and resistance can be defined as the price levels that the bulls and bears have agreed upon to either "catch" a stock's downward movement or the level at which the stock's upward movement will be held back. Support and resistance levels are commonly used to determine and describe the trading range of an issue or index. When the price of a stock falls to a level where buying demand increases significantly and it appears that investors won't let it go lower, a support area is formed. In contrast, when the price of an issue rises to an area where demand decreases and buyers are no longer willing to pay a premium for the stock, a resistance level is formed.

Technicians use historical price charts to find areas of support and resistance. The general trading range of an issue is defined by a series of low points (support) and high points (resistance) within which the stock price moves. The more times that an issue successfully tests a support level or fails near resistance, the more significant that area becomes. When either of these levels are violated, there is a potential for significant movement as investors adjust their positions based on the new character of the issue.

One technique that many investors use for well-defined trading ranges is "rolling" the stock. They buy and sell positions as the issue reaches historically low or high levels, based on its long-term pattern. This technique works well with options, far better than a "buy and hold" approach, and positions with a short-term outlook generally produce the best results for the majority of traders. The reason this method works is because investors tend to remember the past history of the stock and these psychological barriers can last for months at a time.

A "break-out" occurs when the stock penetrates and closes well above or below a defined price support or resistance area. This type of character change has greater meaning when the violation is accompanied by large trading volume.

Most experts agree that when a breakout occurs with significant investor interest, the new technical pattern can be considered quite reliable. Other patterns such as ascending and descending triangles are useful variations of price support and price resistance patterns. They are so named because the direction of the breakout is generally indicated in advance by the shape of the triangle.

Understanding the concept of support, resistance, and trading ranges is a must for successful traders.

 


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