When these support or resistance levels are broken, the supply and demand forces that created these levels are assumed to have moved, in which case new levels of support and resistance will likely be established.
Support is the level at which demand is strong enough to stop the stock from falling any further. In the image above you can see that each time the price reaches the support level, it has difficulty penetrating that level. The rationale is that as the price drops and approaches support, buyers demand become more inclined to buy and sellers supply become less willing to sell. Resistance is the level at which supply is strong enough to stop the stock from moving higher. In the image above you can see that each time the price reaches the resistance level, it has a hard time moving higher.
The rationale is that as the price rises and approaches resistance, sellers supply become more inclined to sell and buyers demand become less willing to buy. These are the people that were uncommitted.
This creates potential demand. They regret selling it and want to right that wrong. This creates more demand. What are you feeling? So do the other owners of the stock. These are just a few examples of many possible scenarios.
There are countless market participants going through the same emotions and thought processes as you, and this is what helps determine some of the market psychology behind support and resistance, and technical analysis in general.
A key concept of technical analysis is that when a resistance or support level is broken, its role is reversed. 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.
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. For this reason, some traders and investors establish resistance zones. Support and resistance share enough common characteristics to effectively 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. Support was established with the October low around In December, the stock returned to support in the mid-thirties and formed a low around After each bounce off support, the stock traded all the way up to resistance.
Resistance was first established by the September support break at After a support level is broken, it can turn into a resistance level. From the October lows, the stock advanced to the new support-turned-resistance level around When the stock failed to advance past The stock subsequently traded up to 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, and 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, there is likely to be an increase in demand and support will be found.
As the stock remained above resistance, was established as a new support level. The stock subsequently rose to , but then fell back to test support at After the second test of support at , this level is well established.
In the above example from PeopleSoft PSFT , we can see that support can turn into resistance and then back into support. PeopleSoft found support at 18 from Oct to Jan green oval , but broke below support in Mar 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 to Oct Where does this overhead supply come from?
Demand was obviously increasing around 18 from Oct to Mar green oval. Therefore, there were a lot of bullish buyers of the stock around 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 The second type of resistance is diagonal, which typically forms in the context of a downtrend. Diagonal resistance is formed by connecting sequentially lower highs. You can see an example of diagonal resistance in Figure 4 within the context of a downtrend. Notice how the stock stopped going up, and resumed the overall downward trend, on several occasions near the diagonal resistance line.
A trader observing this resistance might avoid the stock or even sell. The most effective way to apply support and resistance is to monitor for breakdowns and breakouts. A breakdown is when a stock falls below support. A breakout is when a stock rises above resistance.
One way some traders apply support breakdowns is by selling a stock in anticipation of further downside and in an attempt to limit potential losses. One example of this is seen in Figure 5.
Notice how the stock continued to drop after its breakdown below diagonal support. Some traders monitor stocks near resistance and buy once the stock experiences a breakout above resistance. You can see an example of a breakout above resistance in Figure 6. A trader monitoring this stock may have bought the stock on the day of the breakout and potentially profited in the following days. Selling stocks that breakdown below support, or buying stocks that breakout above resistance, are a few ways to apply support and resistance.
Understanding technical analysis support and resistance. Identifying support. Horizontal support example. Figure 1. For illustration only not a recommendation. Diagonal support example.
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