What Is Support?
Support is like a superhero for prices! It's the level where prices stop going down because there are lots of people who want to buy stuff at that price. So, when prices start dropping and things get cheaper, more people want to buy and fewer people want to sell. When the price reaches the support level, it's like a battle between buyers and sellers. The buyers are so strong that they can stop the price from going any lower. It's like they save the day and keep the price from falling below support.
Sometimes, support doesn't last, and when it breaks, it means the bears (sellers) have won against the bulls (buyers). When the price drops below the support level, it shows that people are now more willing to sell or not interested in buying anymore. When support breaks and new lows are reached, it means sellers are lowering their expectations and are ready to sell at even cheaper prices. Also, buyers won't be convinced to buy unless prices drop below support or the previous low. Once support is broken, a new support level needs to be set at an even lower price.
Where Is Support Established?
Support levels are like safety nets for stocks. They're usually lower than the current price, but sometimes stocks can trade at or close to the support level. Figuring out the exact support level is tricky because technical analysis isn't a perfect science. Prices can be all over the place and sometimes even drop below the support level for a little while. It doesn't make sense to say the support level is broken if the price closes just a tiny bit below it. That's why some traders and investors prefer to think of support zones instead of specific levels.
What Is Resistance?
Resistance is like a wall that stops the price from going up. When the price gets close to this wall, sellers start to sell more and buyers don't want to buy as much. When the price reaches the wall, there are more things being sold than people wanting to buy, so the price can't go any higher.
Sometimes, resistance doesn't stand a chance! When the price breaks above resistance, it means that the buyers are winning the battle against the sellers. It shows that people are more eager to buy or they don't feel like selling anymore. When resistance is broken and new highs are reached, it means that buyers are expecting even better things and are willing to pay more. Plus, the sellers won't sell unless the price goes above resistance or the previous high. Once resistance is broken, a new level of resistance will have to be set at an even higher price.
Where Is Resistance Established?
Resistance levels are like barriers that stocks or other investments have to break through to go higher. Normally, these barriers are set above the current price, but sometimes the price can reach or get really close to the barrier. The price can also jump up and go above the barrier for a short time, even though it doesn't make much sense. Some traders and investors even create zones of resistance because they don't trust these barriers completely.
Methods to Establish Support and Resistance?
Support and resistance are like two sides of a coin. They are kind of like mirror images of each other. Let's look at a chart for a company called Halliburton (HAL) to understand this better.
Between December 1999 and March 2000, the stock price of Halliburton went up and down a lot. When the stock price went down, it found support at certain levels. Support is like a floor that stops the stock price from falling further. In this case, the stock found support around $31 in October, then around the mid-thirties in December, and finally around $32.50 in February.
After each time the stock found support and bounced back up, it reached a level called resistance. Resistance is like a ceiling that stops the stock price from going higher. In this case, the stock faced resistance at around $42.50. This resistance level was first established when the stock broke below a support level in September. Once a support level is broken, it can turn into a resistance level. So, from the October lows, the stock went up to the new resistance level at $42.50. But it couldn't go past that level, so the resistance was confirmed. The stock tried two more times to go above $42.50 but failed both times.
So, support and resistance are important levels in stock trading. They help us understand where the stock price might go next. When the stock price bounces off support, it might go up to resistance. And when it can't go past resistance, it might come back down to support.
Support Equals Resistance
Here's a version for a middle schooler:
Hey there! Let's talk about something called technical analysis. It's a way to understand how the price of something can change. One important idea is that support can become resistance, and vice versa. When the price drops below a support level, that support level can become a barrier or resistance. This means that if the price goes back up to that level, there will probably be more people wanting to sell, which makes it harder for the price to go higher.
Now, the other way around is when resistance becomes support. When the price goes up and breaks through a resistance level, it shows that more people want to buy. This means that if the price goes back down to that level, there will probably be more people wanting to buy again, which makes it harder for the price to go lower. So, support and resistance levels can switch roles depending on what's happening with supply and demand.
Okay, so let's talk about the NASDAQ 100 Index ($NDX) and this cool thing called support and resistance. In May-97, the stock broke through this thing called resistance at 935. It stayed above that level for more than a month, which means 935 became a new support level. The stock then went up to 1150, but later it fell back down to test that support at 935 again. After testing it twice, we can say that 935 is a pretty solid support level.
Now, let's look at an example from a company called PeopleSoft (PSFT). We can see that support can sometimes turn into resistance and then go back to being support again. PeopleSoft found support at 18 from Oct-98 to Jan-99 (that's the green oval). But in Mar-99, the bears (the people who think the stock will go down) were stronger than the bulls (the people who think the stock will go up), and the stock broke below that support. Later, when the stock went up again (that's the red oval), it faced resistance at 18 from Jun-99 to Oct-99.
Now, you might be wondering, where does this resistance come from? Well, from Oct-98 to Mar-99 (that's the green oval), a lot of people were buying the stock when it was around 18. So, there were many bullish buyers (people who think the stock will go up) at that price. But when the price dropped below 18 and went down to around 14, many of those bullish buyers were probably still holding the stock and feeling unhappy. This created a situation where there were more people wanting to sell the stock (supply) than there were people wanting to buy it (demand) at 18. That's why we call it resistance.
When the stock went back up to 18, many of those green-oval-bulls probably took the chance to sell the stock and get out without losing much. Once all those sellers were done, the demand became stronger than the supply, and the stock was able to go above that resistance at 18.
Trading Range
Trading ranges are like a game where prices stay in a small range for a while. It means that the people who want to buy and the people who want to sell are kind of equal. But when the price breaks out of that range, it means that one side has won. If the price goes up, it's a win for the buyers. If the price goes down, it's a win for the sellers.
Let's look at an example with WorldCom (WCOM). After going up a lot from 27 to 64, the stock stayed between 55 and 63 for about 5 months. In mid-June, it looked like the stock was going to break out and go higher, but it was just a trick and it went back down (see the red oval). A few days later, the stock went down even more, canceling out the breakout (see the black arrow). Then, in August 1999, the stock broke the support at 55 and went as low as 50. This is an example of support turning into resistance because the stock bounced off 55 two more times before going even lower. Sometimes, when the price goes back to the new resistance level, it's a chance for people who bought the stock to sell it and for people who want to sell it short to join the fight.
Back in Nov/Dec-99, Lucent Technologies (LU) did this thing where its stock price went up and down in a pattern that looked like a head and shoulders. It's like when you draw a red oval and it looks like a head and shoulders. When the stock price dropped below 60, it happened so fast that people couldn't sell their stocks for more than 44. Looking back, if we drew a blue line that sloped upwards, we could have seen that the stock price would break support at 61. That's only 1 point higher, so people would have had to act really quickly to avoid a big drop. But if you look at the lows on the blue line, they match up pretty well, so it's something to think about when drawing support lines.
After Lucent went down, its stock price stayed between 40.5 and 47.5 for almost two months. We call this a trading range, and it's like the stock price is stuck in a certain range. The highest point it reached was 47.5, and it happened three times, so we know that's a strong resistance level. The lowest point wasn't as clear, but it seemed to be between 40 and 41. Then, in February, people started buying the stock when it was around 44. You can see these candlesticks with long lower shadows, which we call hammers. It means that people were interested in buying the stock. Then, on Feb 24 and 25, the stock price went up really fast and closed above 48. This showed that there was a lot of demand for the stock. There were still two more chances to get in on the action. On the third day after the stock price went up, it went up even more and went above 56.
Support and Resistance Zones
Technical analysis is a way to study stocks and figure out when to buy or sell them. It's not an exact science, so it's helpful to create support and resistance zones. This means we set certain levels where the stock price is likely to go up or down. Each stock is different, so we have to look at its own characteristics. Sometimes, we can be very specific about the support and resistance levels, and sometimes it's better to have a range. The smaller the range, the more specific we can be. If the stock price has stayed within a small range for less than 2 months, then it's best to have specific levels. But if the stock price has been going up and down for many months and the range is big, then it's better to have a range instead. These are just general guidelines, and we have to look at each stock's situation on its own.
Now let's look at an example with Halliburton. In November, the stock price went from 32 to 44, which is more than 20% higher than the low in October. This means the range is big compared to the price. We can use the break in support from September as our first resistance level. After the stock price reaches the high point in November, we can set up a resistance zone, probably around early December. But we're not sure yet if the stock will keep going up and down in a big range. In December, the stock price went down a little but stayed higher than the low in October. This shows that a trading range might be forming, so we can set up a support zone. As long as the stock price stays within the support and resistance zones we set, we will consider the trading range to be valid. When the stock price hits the support level, it can be a good time to buy, and when it hits the resistance level, it can be a good time to sell.
Conclusion
Finding the important levels where a stock's price might go up or down is super important for technical analysis. Sometimes it's hard to figure out exactly where these levels are, but just knowing they exist and where they might be can really help you make better predictions. If a stock is getting close to an important level where it might go up, that's a sign to pay extra attention and look for signs that more people are buying and the price might turn around. On the other hand, if a stock is getting close to a level where it might go down, that's a sign to look for signs that more people are selling and the price might turn around. If a level gets broken, that means the balance between how much people want to buy and sell has changed. If the price breaks through a level where it used to go up, that means the people who want to buy have taken control. And if the price breaks through a level where it used to go down, that means the people who want to sell have won.
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