Technical analysis of the stock market is the study of stock prices for indications of where the prices will go in the future. The concepts of support and resistance levels are basic building blocks of the technical analysis of stocks. Even if you are an investor who buys stocks on the fundamentals, an understanding of support and resistance can help with your stock purchase timing.
Using Stock Price Charts
Stock price support and resistance levels are found using price charts of the stock's historical values. You need access to some form of stock charting software to visualize and plot these share price levels. There are websites that provide free charting services, or your online brokerage account may provide charting for technical analysis. Select a charting package that allows you to add lines to a stock price chart to plot and use support and resistance levels.
Stock Support Levels
A stock support level is a value that the share price has declined to several times but not continued on to lower values. On a chart of the stock share price, the support level is indicated by a horizontal line with the share value coming down to the line several times before returning to higher price levels. A correctly drawn support level has several touches or near touches with the price moving higher after each approach to the support price. A support price puts a floor on the expected trading range of a stock's share value.
A resistance level is a stock price that the share value has touched but not been able to move through to the upside. The resistance level is a horizontal line at the top of the share price chart at the price the share value has not exceeded for the time period being reviewed. Resistance and support levels are at the upper and lower extremes of the current stock price trading range. The resistance level is the top of the expected stock price trading range.
Establishing Support and Resistance Levels
A stock share price can be moving in an uptrend, a downtrend or moving sideways in a trading range. The support and resistance levels are the boundaries of a trading range bound stock price. The more times the share price approaches or touches a support or resistance level without breaking through, the more validity the level has for traders. There is some art involved in recognizing and plotting support and resistance levels. Practice helps you pick the levels out with a higher level of certainty.
Trading Support and Resistance
One of two things can happen when a stock share price approaches a support or resistance level. If the level holds, the share price will reverse and the trader can attempt to profit as the share value moves toward the opposite level. If the share price breaks through a level, it is the possible indicator of a new up or down trend. At that point, the old support or resistance level can be viewed as a new resistance or support level.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.