Earn Huge Profits Investing in the
Largest Financial Market in the World...

 

Section 3:

Support and Resistance I

 

Support and resistance are the building blocks of price patterns. Support and resistance are two of the most important concepts that traders need to master.

Support is a price at which a stock stops going down. Support is where sellers and buyers, or supply and demand, equalize to cause a leveling out in price action. Support generally forms after bearish trends.

Resistance is a price at which a stock stops going up. Resistance is where buyers and sellers, or demand and supply, equalize to cause a leveling out in price action. Resistance generally forms after bullish trends.

Support and resistance materialize in two different forms. These levels can be horizontal, revealing a static price at which support or resistance exists. Alternatively, support and resistance can be diagonal levels.

Diagonal support and resistance levels are common in the stock market, especially when a stock is trending strongly in either direction. Diagonal support and resistance levels are identical in concept to horizontal support and resistance levels. The only difference is that diagonal support and resistance levels follow a stock’s movement higher or lower.

Horizontal Support

Horizontal support is a price at which a stock stops going down. It truly is that simple. It’s a price lower than the current price below which a stock isn’t moving. Think of support as a floor for the stock.

A stock might be trending lower, but eventually it reaches a price at which buyers perceive it as attractive. They start buying, equalizing or overcoming the sellers. The buying causes the price to stop going lower and start moving higher.

3.1.png
Figure 3.1

Notice how the Russell 2000 iShares (IWM) stop going lower near the $74 level as shown in Figure 3.1. There are several bearish trends that stop once the IWM reaches the $74 level.

Observe how the IWM trades a little bit below the $74 level on several occasions. The stock reverses higher each time it trades near $74. This is support in action.

But support can be broken. In fact, support is often broken, leading to new bearish trends. The break of support can lead to actionable entry points or exit points. Generally the more a support level is tested the weaker it becomes.

3.2.png
Figure 3.2

Shares of American Airlines (AMR) found support near the $20 level for several months as shown in Figure 3.2. Notice how the stock stopped moving lower each time it dropped to near the $20 level. But after testing the level for the fifth time, the stock finally lost support and proceeded to fall significantly lower.

Horizontal Resistance

Horizontal resistance is very similar to support in concept. The only difference is that resistance is above the current market price.

Horizontal resistance is a price at which a stock stops going up. It’s a higher price than the current price above which a stock isn’t moving. Think of resistance as a ceiling for the stock.

A stock might be moving higher, but eventually it reaches a price at which sellers perceive it as overvalued. They start selling, equalizing or overcoming the buyers. The selling causes the stock to stop going higher and start moving lower.

3.3.png
Figure 3.3

Notice how shares of McDonalds (MCD) stop going higher near the $51 level, after a strong bullish trend as shown in Figure 3.3. The stock fails to break through the $51 level on three separate attempts, which are spread across three months.

MCD did briefly break through the $51 level on several separate occasions, but it never held. This is an example of why to treat resistance as an approximate level and not an exact number.

Horizontal resistance is often broken, generally leading to new bullish trends. The break of resistance is actionable, offering new entry points into bullish trends. Just like support, the more often a resistance level is tested, the weaker it becomes.

3.4.png
Figure 3.4

The Diamonds (DIA), which is a stock that tracks the Dow Jones Industrial Average, found resistance at the $135 level after a big bullish trend shown in Figure 3.4. The DIA ran into the $135 resistance level three times before finally breaking above. The DIA ran substantially higher in a short period of time after breaking the $135 level.

Diagonal Support

Diagonal support is a price at which a stock stops going down within the context of a bullish trend. The lows for each period, or over the course of multiple periods, tend to move higher. It’s a price lower than the current price below which a stock isn’t moving. Think of diagonal support as an escalator moving up, steadily lifting the price of a stock.

A stock might be moving higher, but along the way it pauses and pulls back to catch its breath. Each time it pulls back, the buyers step in at increasingly higher prices. They start buying, equalizing or overcoming the sellers. The buying causes the price to stop going lower and start moving even higher.

3.5.png
Figure 3.5

Shares of First Solar (FSLR), shown in Figure 3.5, moved higher along the path of a diagonal support line. Notice how the stock quickly rebounded after falling to the support line.

But the level of support moved higher along with the stock price. Support wasn’t a static level. Notice how each bounce from support came from an increasingly higher level in price: $45, $52.50, $57.50, and $62.50.

Diagonal support levels are often broken. When diagonal support breaks, it generally signals an end to a bullish trend. The break of diagonal support can be used as an action point, either to exit a profitable trade or to enter a new bearish position.

3.6.png
Figure 3.6

Shares of Google (GOOG) trended sharply higher, gaining over $200 per share in a short period of time as shown in Figure 3.6. The stock used as an aggressive diagonal support line to trend higher, bouncing from it along the way.

The stock finally broke down below its diagonal support line, signaling an end to the bullish trend. Notice by how much the stock continued to fall after it broke down below diagonal support near the $700 level.

Diagonal Resistance

Diagonal resistance is a price at which a stock stops going up within the context of a bearish trend. The highs for each period, or over the course of multiple periods, tend to move lower. It’s a price higher than the current price above which a stock isn’t moving. Think of diagonal resistance as an escalator moving down, steadily forcing the price of a stock lower.

A stock might be moving lower, but along the way it pauses and bounces higher. Each time it bounces higher, the sellers step in at increasingly lower prices. They start selling, equalizing or overcoming the buyers. The selling causes the price to stop going higher and start moving even lower.

3.7.png
Figure 3.7

Shares of Centex (CTX) trended steadily lower, using diagonal resistance as shown in Figure 3.7. The stock fell by more than 50 percent under the weight of diagonal resistance.

Notice how the rollovers from diagonal resistance occurred at lower levels: $40, $30, $26, and $24.

Diagonal resistance levels are often broken. When diagonal resistance levels break, it often marks the end of a bearish trend and the beginning of a new bullish trend. The breaks of diagonal resistance are actionable and can signal exit points from existing bearish positions or entry points into new bullish positions.

3.8.png
Figure 3.8

Shares of General Motors (GM) trended lower for several months, using the trajectory of the diagonal resistance level shown in Figure 3.8. The stock rolled over from the diagonal resistance at $37.50, $36.50, $35, and finally near $31.50.

The stock eventually broke the pattern of lower lows, as marked by the diagonal resistance line, and proceeded to rocket higher. Sometimes a stock will see explosive moves after breaking horizontal resistance. That’s because of the collective fear of the short sellers. These sellers turn into buyers and rush to cover, leading to explosive moves.