Support and Resistance

Another way of looking at peaks and troughs in a price chart is using the concept of support and resistance. Again, this is a fundamental idea used in technical analysis, and the various aspects of it can be very powerful.

The troughs, or low points, can be thought of as support points – they are the level down to which the price can go, but no lower. The price is supported at that level because the buying interest is strong enough to overcome the amount of selling. As a result, the price goes down to that level and turns back up again.

Similarly the peaks indicate the resistance level. When the price gets that high, a lot of traders decide to sell and take their profits, and the excess of supply over demand or buying interest turns the price back.

This is a progressive process. In an uptrend the price will hit a resistance point and be turned back down to retrace some of the previous gain. But if the major uptrend continues, you can expect the price to rise back up to the resistance and pass through it to a higher level. It’s almost as if the price is pausing for breath when it first hits resistance, and the next time around it gets some momentum up to break through. Here’s a chart to show the idea.

Clearly this chart shows an uptrend, with progressively higher peaks and higher troughs. Note that support and resistance are horizontal lines at certain price levels—later we’ll get onto lines that are angled and follow the trend.

We can do exactly the same, showing support and resistance in a downtrend, and that is represented in the following chart.

These are well behaved trending stocks. If the line did not progress like this, then that could be a sign that the trend is changing. For instance, if in the chart above the second time the price met resistance it only dropped down to the previous support level before going back up, and didn’t go to a lower level, then you would have to consider that the downtrend was failing.

This is a sign that you would not ignore. In fact, as you’ll see in the next module on patterns, this is one of the classic bottom reversal patterns, and might well herald a change to an uptrend. Here’s a picture of that.

This is called a double bottom reversal. As with many of these patterns, there is a mirror image called a double top, which is when an uptrend reverses to become a downtrend, and here’s what that looks like.

Again, these and other patterns will be discussed in the next module. These patterns aren’t guaranteed to start reversals, as not much can be guaranteed in analyzing the markets, but historically the odds point towards it. The important point is that in an uptrend you expect the successive resistance and support levels to be higher for the trend to be sound. In a downtrend, the opposite applies and the support and resistance levels should be getting lower, otherwise it’s a red flag. Here’s a real stock chart showing a double top and reversal.

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