Resistance in technical analysis is a price level that a rising stock can’t seem to overcome. Once a stock reaches resistance, it often stalls and reverses. Resistance is caused by heavy selling that overpowers buying, and typically occurs at specific price levels.
Draw a line on a daily stock chart connecting two or more recent peaks. The line may come out up-sloping, down-sloping or horizontal, but regardless of the angle, you'll see how each time a stock approached it, it reversed.
Support vs. Resistance
If you connect two or more recent price lows, you'll obtain another important trend line called support; each time a stock reached it, it stopped declining and reversed. When a stock declines, it may form several levels of support in which its price stabilizes and bargain hunters start buying on the assumption that the stock has reached bottom, but the stock may break through support and continue lower. Investors who bought at support vow to sell as soon as they break even – that is, when the declining stock comes back up to the former support level at which they bought it. At some point, the stock stops declining and turns back up. Each time it reaches a former support level, these bargain hunters start selling. Their selling stymies the advance – former support becomes new resistance. The more shares were purchased at an old support level, the stronger the new resistance will be.
Traders who understand human psychology in the market start taking profits as soon as a stock reaches a former support level. But resistance is harder to explain when a stock is making new highs in the absence of support to form a new resistance barrier. Every stock fluctuates with different amplitude: some advance in tight patterns, others make wide and lose swings, but they all stop at the resistance line. The reason may be purely psychological: Other traders draw exactly the same lines and start selling at exactly the same levels, so resistance becomes a self-fulfilling prophecy.
Some investors set price targets based on profit objectives. For example, a fund may decide to sell a stock when it’s up 20 percent or when it reaches a specific price. If enough investors decide to sell at the same price level, their collective selling will cause resistance.
Video of the Day
- Technical Analysis of Stock Trends; Robert D. Edwards, et al.