Support and Resistance are among the base concepts of Technical Analysis. In this article we will define the concepts and describe how you can identify Support and Resistance on stock charts, as well as how ChartMill can do this for you with several available Support and Resistance indicators.
Support and Resistance definition
- Support as the price level, area or zone where we expect an increased demand from buyers, thereby giving support to the price level and preventing price to move further downwards.
- Resistance as the price level, area or zone where we expect an increased supply from sellers, thereby giving resistance to the price level and preventing the price to move further upwards.
Important to note here is that we are referring to a price level, area or zone. Support or Resistance are hardly ever at a single price level. So even when prices go a single tick above an identified resistance level, it does not mean the level has been broken yet.
An important question is of course why this is the case. Why is it that we consider a certain level as a magic number where we expect a certain behavior from the stock. There are several reasons why this could be the case:
- The stock is just considered expensive at the resistance level and cheap at the support level. Certainly because certain levels have shown to be local bottoms or tops in the past, traders may feel this is a good price to either get in or get out of the stock.
- Investors and traders have a memory and remember how the stock acted the previous time it was around the support or resistance level. If you believe there is not much room to go higher it may be a good time to sell (and thereby contribute to the resistance) or when you believe downside is very limited it may be a good time to buy (and thereby contributing to support).
- Because Support and Resistance is one of the basic concepts in Technical Analysis, many traders and investors will be watching these levels and acting upon them. This is the self fulfilling prophecy of Technical Analysis.
- Support is hit after a decline, resistance after a run up. So it is very normal that after a run up there will be quite some people with a profit wanting to realize the profit.
- Finally and just to make this clear: support and resistance are levels where we expect price to turn, but of course there are never and guarantees!
How to find Support and Resistance
2 typical ways of identifying support and resistance are:
- Horizontally aligned tops and bottoms.
- Trendlines by connecting multiple tops or bottoms.
Horizontally aligned tops and bottoms.
Stocks form tops and bottoms. A bottom for instance is a local price formation where prices on both sides (earlier and later) are above the lowest price in the range. When multiple tops or bottoms (or both) are horizontally aligned on the chart (or happen at the same price), we can identify an area of support or resistance by drawing a horizontal line at this level.
This is visualized on the chart below:
On the long term chart of EPD, we see 3 tops which are horizontally aligned (T1, T2, T3) and 3 bottoms (B1, B2, B3). A forth top (T4?) may be forming as we can assume resistance to be present around the 29.5 level.
Horizontal lines may also change their role. It is not uncommon that a strong resistance line will act as support after it was broken. An example can be found on the long term AXS chart:
ChartMill Channels, as described in the linked article, are horizontal lines which identify the current trading range of the underlying stock and are also excellent tools to indentify support and resistance.
Trendline formations by connecting multiple tops or bottoms.
Tops and bottoms need not to be aligned horizontally. They also occur in trending stocks. When the stock always forms higher bottoms (higher lows) we can draw a line which connects the different bottoms. This is called a trendline and the trendline will act as support for the next bottom formation. An example can be found in the long term chart of ES below:
Inversely, when the stock is in a downtrend it will make lower tops (lower highs). Here we can draw a line which connects the different tops. This is called a resistance line and will act as resistance on the way down. An example of such a line can be found on the chart of MSM below:
Support and Resistance Chart Indicators.
Good news! ChartMill has several indicators available in the Stock Charts which draw support and resistance lines automatically on the charts:
- Support and Resistance overlay indicator: this indicator draws both horizontal lines as well as support and resistance trendlines by connecting multiple bottoms or tops. All the charts above use this indicator.
- ChartMill Channels overlay indicator: this indicator draws horizontal lines which identify the current trading range of the underlying stock.
- ChartMill Consolidated Support and Resistance overlay indicator: this indicator displays different zones of support and resistance which are computed from several support and resistance indicators in different timeframes.
Support and Resistance Notes
- All methods for determining support and resistance can be applied in different time frames. Typically we can say that the larger the time frame the more significant the support or resistance will be. ( A trend line on a weekly chart has more meaning than one on an intraday chart).
- The more often a support or resistance line was tested, the more significant it will be. If you can create a trendline by connecting 5 bottoms it has more meaning than when only 2 are connected. In ChartMill we have the concept of line strength to indicate the significance.
- The more recent the confirmation of a support or resistance line was, the more significant the line is. Too often we see traders paying attention to a line with only some touchpoints a couple of years back. As these levels have been a long time ago they should not play that big a role anymore as the stock will have new shareholders who do not remember these levels.
- The ChartMill Consolidated Support and Resistance overlay indicator takes all these items into consideration when determining the consolidated support and resistance levels.
Support and Resistance Trading Strategies.
We refer to our article on Support and Resistance Trading Strategies for more information on how to use the Stock Screener for finding stocks which shown tradable support or resistance patterns.
For some additional background on Support and Resistance concepts we refer to this article on investopedia.
The ChartMill Team