Support and Resistance Basics

Traders and analysts chart the movements of stock prices over time to pinpoint the support levels and resistance levels that indicate optimal times to buy and sell.

Support and resistance are two foundational concepts in technical analysis. Understanding what they are and how they work is essential to correctly reading a price chart.

Technical analysis acknowledges that all stocks rise and fall in price constantly in response to supply and demand. By zeroing in on movements within a timeframe, they seek to identify patterns. A stock's price may maintain a support level, below which its price won't drop. It may also show a resistance level, at which buyers back off.

Like many concepts in technical analysis, the explanation and rationale are relatively easy, but mastering their application can take years of practice.

What Is Support?

In a downtrend, prices fall because there is an excess of supply over demand. The lower prices go, the more attractive they become to those waiting on the sidelines to buy the shares.

At some level, demand that would have been slowly increasing will rise to the level where it matches supply. At this point, prices will stop falling. This is support.

Support can be a single price level on the chart or a price zone. In any event, support is an area on a price chart that shows buyers’ willingness to buy.

It is at this level that demand will usually overwhelm supply, causing the price decline to halt and reverse.

What Is Resistance?

Resistance is the opposite of support. Prices move up because there is more demand than supply. As the prices move higher, there will come a point when selling will overwhelm buying.

This happens for a variety of reasons. It could be that traders have determined that the prices are too high or have met their targets. It could be the reluctance of buyers to initiate new positions at such rich valuations.

It could be for any other number of reasons. But a technician can clearly see on a price chart a level at which supply begins to overwhelm demand. This is resistance. Like support, it can be a level or a zone.

Once an area or zone of support or resistance has been identified, those price levels can serve as potential entry or exit points because, as the price reaches a point of previous support or resistance, it will do one of two things: bounce back away from the support or resistance level, or violate the price level and continue in its prior direction—until it hits the next support or resistance level.

The timing of some trades is based on the belief that support and resistance zones will not be broken. Whether the price is halted by or breaks through the support or resistance level, traders can bet on the direction of the price and quickly determine if they are correct.

If the price moves in the wrong direction (breaks through prior support or resistance levels), the position can be closed at a small loss. If the price moves in the right direction (respects prior support or resistance levels), the move may be substantial.

The Basics

Support and resistance can be found in all charting time periods; daily, weekly, and monthly. Traders also find support and resistance in smaller time frames like one-minute and five-minute charts. But the longer the time period, the more significant the support or resistance.

To identify support or resistance, you have to look back at the chart to find a significant pause in a price decline or rise. Then look forward to see whether a price halts or reverses as it approaches that level.

Many experienced traders will pay attention to past support or resistance levels and place trades in anticipation of a future similar reaction at these levels.

Why It Works (Or Doesn't)

Technical analysis is not an exact science, and sometimes the price will dip below support levels or reverse before it gets to the prior support level. The same is true for resistance: The price may reverse before it gets to the prior resistance level or break above it.

In any case, flexibility is required in interpreting these chart patterns. This is why support and resistance levels are sometimes zones rather than precise numbers.

There is nothing magical about these price levels. It is simply that many market participants are acting off the same information and placing trades at similar levels.

Most experienced traders can share stories about how the price of an asset tends to halt when it gets to a certain level.

For example, assume that Jim was holding a position in a stock from March to November and that he was expecting the value of the shares to increase.

Let’s imagine that Jim notices that the price fails to get above $39 several times over several months. Traders would call the price level near $39 a level of resistance.

As you can see from the chart below, resistance levels are also regarded as a ceiling because these price levels represent areas where a rally runs out of gas.

Support levels are the flip side of the coin. Support refers to the price level on a chart at which equilibrium is reached.

Demand has increased to match supply. This causes the decline in the price of the asset to halt. The price has reached a floor.

As you can see from the chart below, the horizontal line below the price represents the price floor. You can see by the blue arrows underneath the vertical line that the price has touched this level four times in the past. This is the level where demand comes in, preventing further declines. This is support.

Trendlines

The examples above show that a constant level prevents an asset’s price from moving higher or lower. This static barrier is one of the most popular forms of support/resistance.

But the prices of financial assets generally trend upward or downward, so it is not uncommon to see these price barriers change over time. This is why the concepts of trending and trendlines are important when learning about support and resistance.

When the market is trending to the upside, resistance levels are formed as the price action slows and starts to move back toward the trendline. When the price is moving against the prevailing trend, it is called a reaction.

Reactions can occur for a large variety of reasons, including profit-taking or near-term uncertainty for a particular issue or sector. The resulting price action undergoes a plateau effect, or a slight drop-off in stock price, creating a short-term top.

Many traders will pay close attention to the price of a security as it falls toward the broader support of the trendline because, historically, this has been an area that has prevented the price of the asset from moving substantially lower.

For example, as you can see from the Newmont Corp. (NEM) chart below, a trendline can provide support for an asset for several years. In this case, notice how the trendline propped up the price of Newmont’s shares for an extended time.

On the other hand, when the market is trending to the downside, traders will watch for a series of declining peaks and will attempt to connect these peaks together with a trendline. When the price approaches the trendline, most traders will watch for the asset to encounter selling pressure and may consider entering a short position because this is an area that has pushed the price downward in the past.

To be a valid trendline, the price needs to touch the trendlines at least three times. Sometimes with stronger trendlines, the price will touch the trendline several times over longer time periods.

Uptrends and Downtrends

In an uptrend, the trendline is drawn below the price, while in a downtrend, the trendline is drawn above the price.

The support/resistance of an identified level, whether discovered with a trendline or through any other method, is deemed to be stronger the more times that the price has historically been unable to move beyond it.

Many technical traders will use their identified support and resistance levels to choose strategic entry/exit points because these areas often represent the prices that are the most influential to an asset’s direction.

Most traders are confident at these levels in the underlying value of the asset, so the volume generally increases more than usual, making it much more difficult for traders to continue driving the price higher or lower.

Round Numbers

Another common characteristic of support/resistance is that an asset’s price may have a difficult time moving beyond a round number, such as $50 or $100 per share. Because people have an easier time visualizing round numbers, many inexperienced traders tend to buy or sell assets when the price is at a round number.

Also, many target prices or stop orders set by either retail investors or large investment banks are placed at round price levels. Because so many orders are placed at the same level, these round numbers tend to act as strong price barriers.

For example, if all the clients of an investment bank put in sell orders at a suggested target of $55, it would take a large number of purchases to absorb these sales and create a new level of resistance.

Moving Averages

Most technical traders incorporate the power of various technical indicators, such as moving averages, to aid in predicting future short-term momentum. In fact, people who find it difficult to draw trendlines often will substitute them for moving averages.

As you can see from the chart below, a moving average is a constantly changing line that smooths out past price data, allowing for easier identification of support and resistance. Notice how the price of the asset in the chart below finds support at the moving average when the trend is up, and how it acts as resistance when the trend is down.

Traders can use moving averages in a variety of ways, such as to anticipate moves to the upside when price lines cross above a key moving average, or to exit trades when the price drops below a moving average.

Regardless of how the moving average is used, it often creates automatic support and resistance levels. Most traders will experiment with different time periods in their moving averages so that they can find the one that works best for their trading time frame.

Other Indicators

In technical analysis, many indicators have been developed and are still being developed to identify barriers to future price action. Some indicators are plotted on price charts, while others are plotted above or below the price.

It takes practice and experience to learn to use them effectively. But regardless of how complex an indicator appears, its use and interpretation are often no different from that of indicators created through simpler methods like calculating moving averages and drawing trendlines.

For example, the Fibonacci retracement is a favorite tool among many short-term traders because it clearly identifies levels of potential support/resistance. Notice in the chart below how the identified levels (dotted lines) are barriers to the short-term direction of the price.

Trading Ranges

Support and resistance levels can often be relatively close. The stock price bounces between the two levels, sometimes for a long time, without ever showing a long-term direction.

Some traders focus on exploiting these sideways trends. One strategy is to place short trades as the price touches the upper trendline and long trades as the price reverses to touch the lower trendline.

This strategy is extremely risky. It is much better to wait to see in which direction the price will break out of the range and then place your trades in that direction.

Support and Resistance Reversals

A previous support level will sometimes become a resistance level when the price attempts to move back up. A resistance level can become a support level as the price temporarily falls back.

Price charts allow traders and investors to visually identify areas of support and resistance, and they give clues regarding the significance of these price levels. More specifically, they look at:

Number of Touches

The more times that the price tests a support or resistance area, the more significant the level becomes. When prices keep bouncing off a support or resistance level, more buyers and sellers notice and will base trading decisions on these levels.

Preceding Price Move

Support and resistance zones are likely to be more significant when they are preceded by steep advances or declines.

For example, a fast, steep advance or uptrend will be met with more competition and enthusiasm and may be halted by a more significant resistance level than a slow, steady advance. A slow advance may not attract as much attention. This is a good example of how market psychology drives technical indicators.

Volume at Certain Price Levels

The more buying and selling that has occurred at a particular price level, the stronger the support or resistance level is likely to be. This is because traders and investors remember these price levels and are apt to use them again.

When strong activity occurs on high volume and the price drops, a lot of selling will likely occur when the price returns to that level, since people are far more comfortable closing out a trade at the breakeven point than at a loss.

Time

Support and resistance zones seen in longer time frame charts such as weekly or monthly charts are often more significant than those seen in shorter time frame charts such as the one-minute or five-minute chart.

The Bottom Line

Support and resistance levels are key concepts that form the basis of a wide variety of technical analysis tools. The basics of support and resistance consist of a support level, which can be thought of as the floor under price, and a resistance level, which can be thought of as the ceiling above price. Prices fall and test the support level, which will either hold, and the price will reverse to the upside, or be violated, and the price will drop through the support and likely continue lower to the next support level.