A stock's advance often resembles a staircase: a spurt followed by a consolidation. When a stock consolidates, it trades in a range: each time it advances, it stalls below a certain level and reverses lower; each time it declines, it stops above a certain level and reverses higher, as if hitting an invisible ceiling and floor. These levels are called resistance and support. Investors use technical analysis to determine a stock's support and resistance levels.
1. Obtain daily charts for each of your stocks going back 9 to 12 months and examine them carefully.
2. Identify key turning points where a stock changed direction from up to down and vice-versa.
3. Draw a line through at least two key turning points where a stock stopped advancing and turned back down. This is a ceiling, or resistance.
4. Draw another line through at least two key turning points where a stock stopped declining and turned back up. This is a floor, or support. When drawn properly, support and resistance lines are often almost horizontal and parallel to each other, or slightly slanted.
5. Count the number of times a stock touches support or resistance. The more times a stock touches support or resistance, the more significant those levels are and the more valid the lines.
6. Extend the lines beyond the right end of the chart to pinpoint future possible support and resistance levels. Your stock is likely to make the same up and down turns around those price levels in the near future.
- Use online charting services to learn how to draw support and resistance lines, and practice as much as you can.
- Be consistent with where your draw support and resistance lines. There is no one correct level. Some technicians draw lines through absolute price peaks; others ignore the peaks and use major price congestion areas where most of the shares traded. That is why support and resistance are not specific prices but general levels, or price ranges.
- Stay flexible. Support and resistance are not set in stone. There are minor and major levels depending on how many shares traded at a particular level or how long a particular level has existed. Stocks periodically break through support or resistance lines, establishing new support and resistance levels. In a rising stock, a former resistance often becomes a new support; in a declining stock, a former support often becomes a new resistance.
- Be prepared for mistakes and failures. Technical analysis is a support tool, not a precise science: traders make mistakes and chart patterns fail.
- "Technical Analysis of Stock Trends"; Robert D. Edwards, John Magee; 2010
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