The Concept of Support and Resistance in Stock Prices
Support and resistance are two of the most important concepts that you need to grasp when it comes to technical analysis and using stock charts. Both have to do with the price action of a stock and areas where a stock has trouble continuing to go higher or continuing to decline in price. They are areas of significant importance on any stock chart.
Support is the price area where enough buyers come into a stock to halt a downward move in prices for a long amount of time. For example if a stock falls from $10 to $5 and then holds the $5 level and goes back up then $5 can be called a support level for a stock. And if this is a pattern that keeps repeating it becomes a very significant support level.
If this $5 area were to end up failing as support than it could mean that something big is changing with the stock in a negative way. That is why support levels make logical places to put stop loss orders.
Now resistance is the opposite of support. Resistance prices are price points where a stock has trouble going higher. In our example let's say every time a stock went up to $10 it fell back down. It did this over and over again and couldn't beat ten. Well then you would have to consider ten a big resistance area.
If ten got taken out on good trading volume than that would be a sign that the stock would now likely go up more until it finds another big resistance point at maybe $15 a share or $20 a share.
Another way to think about support and resistance is to think of them as areas of demand and supply for a stock. Demand for a stock comes in at a certain price that is perceived to be cheap that it prevents it from falling more and supply comes in when the stock prices seem to be expensive to the people involved in the stock.
However these notions of when a stock is cheap and when it may be expensive are dynamic and change based upon news that comes out on a stock, people’s perceptions of the future, and even more importantly their own reaction to stock price movements, a concept billionaire hedge fund manager George Soros termed “”reflexitivity” in the financial markets.
These concepts of supply and demand are the theoretical underpinnings of technical analysis. For more sign up to my free newsletter below.
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