Support and resistance are one of the most valuable charting tools of technical analysis. They are price levels or areas on charts that tend to act as barriers, preventing the price of a stock from moving further in a certain direction.
Support is a price level that normally begins at a recent extreme of a correction low, where demand is thought to be strong enough to prevent the price from declining further. If the price of a stock falls towards its support level, buyers should be prepared to take action and short sellers may have to cover, thus creating demand and causing the stock to rise and move away from its support level. In such a case support would be confirmed. Support is broken if the price declines further and another support level will eventually be established at a lower level.
Resistance is a price level that normally begins at a recent extreme price peak, where sellers are inclined to sell and buyers become less inclined to buy, thus creating more supply than demand and preventing the price from rising further. If resistance is broken, it signals buyers are willing to buy at higher prices and sellers are also waiting for high prices and a new resistance level will be established at a higher level.
Resistance and support levels can be drawn as horizontal lines where there is a constant level preventing the price from moving higher or lower. However, prices generally are not static and trend upwards or downwards, changing these barriers over time, thus creating trendlines. An uptrend continues when the most recent peak is surpassed and new peak levels are reached. In a up move, low points are connected to form an uptrend line. A downtrend continues with a series of declining peaks, creating a series of lower lows and lower highs. In down move, peaks are connected to form a downtrend line.
The chart demonstrates how the stock runs into resistance and falls as it reaches a prior high and maintains support and rises at a prior low. When resistance is finally broken, signaling that demand has gained the upper hand, the price rises and eventually finds support at the previous resistance level. Thus previous resistance has now become support.
Anthony Galliano is the chief executive officer at Cambodian Investment Management.