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Stocks & Commodities V17:1 (55-58): Support And Resistance by Stuart Evens
NOVICE TRADER

Support And
Resistance A B C
D EF

METASTOCK (EQUIS INTERNATIONAL)

Support and resistance are basic tools used by traders to
identify key reversal areas. Here’s a look at the basics of
support and resistance levels and how to determine which
levels might be important in the future.

by Stuart Evens
FIGURE 1: RUBBERMAID. Here, we see the 271/2 price level first acting as
ne premise of technical analy- resistance (points A, B, and C), and then acting as support (D, E, and F).
sis is that stock prices are af-
fected by support and resis-
tance. As those terms imply, any further downward movement in prices for an appreciable

O support acts to keep a stock’s

price above a certain level,
while resistance acts to keep a
stock’s price below a certain
level. In fact, once it has been
period. Resistance is the opposite of support; it is selling,
either actual or potential, in sufficient volume to satisfy all
bids, thereby preventing prices from going any higher for a
while. These definitions are quite similar but not identical to
the terms demand and supply, respectively.
determined that a price has acted The term support level refers to the price at which buyers
as important support or resis- are willing to step in and buy enough shares of stock to
tance in the past, it is very likely temporarily stop or possibly reverse a downtrend. Con-
that a particular price will do so versely, a resistance level is the price at which sellers are
again in the future. Drawing support and resistance lines on willing to sell enough shares of stock to temporarily stop and
stock charts helps determine how significant they were in the possibly reverse an uptrend. In terms of supply and demand,
past and how significant they might be again. If we find a support is the price level at which the demand for the stock
stock trading toward one of these price levels, we can make exceeds its supply, and resistance is the price level at which
some reasonable predictions as to how the stock price might the supply of stock exceeds its demand. An example can be
respond. We can then make trading decisions based on this seen in Figure 1.
anticipated price action. Figure 1 is a daily chart of Rubbermaid [RBD] from June
What are support and resistance, and why do they occur at
definite price levels? What do they look like on price charts?
To help answer these questions, we will take a look at the
charts of stocks with clearly identifiable support and resis- F
tance levels and draw the lines on the charts. Using the
information we glean from doing so, we can estimate the
probability of these levels acting again as support or resis-
tance when prices approach these levels.
A B C D E
But first, let us define some of these terms and look at what
causes the formation of support and resistance.

DEFINITIONS
Anyone who has watched financial news programs on televi-
sion has probably heard technicians make such comments as
“I see support for the Dow at 7300” or “The Dow should
experience some resistance at about 8100.” So what do these
financial pundits mean by support and resistance?
Robert Edwards and John Magee, in their classic work
FIGURE 2: OUTBACK STEAKHOUSE. The 341/2 price level acts as a very strong
Technical Analysis Of Stock Trends, define support as buy- level of support in this stock, as prices are prevented five times from breaking that
ing, either actual or potential, in sufficient volume to prevent level (A-E).

Copyright (c) Technical Analysis Inc.

 Stocks & Commodities V17:1 (55-58): Support And Resistance by Stuart Evens

BRUCE WALDMAN

1997 to September 1998. The chart shows three times (points A-C, and then reversing roles and acting as support at D-E;
A, B, and C) that prices trade up to about 271/2 and then this is actually a commonplace occurrence.
reverse and fall back. Then, once prices finally break through
the 271/2 level, as happened in February 1998, prices trade EXPLANATION
down to the same level (D, E, and F) before resuming the To explain this behavior, let’s take a closer look at Figure 1.
rally, up to about 35. A line is drawn to be as close to all six Starting in mid-July 1997, after falling from about 30, the
of these points as possible to indicate this level’s signifi- stock rallies to about 271/2 in August, pulls back, rallies again
cance. Here, we see a price level acting first as resistance at to about 271/4, and pulls back again. This occurs one more
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V17:1 (55-58): Support And Resistance by Stuart Evens

time in January 1998 before finally pushing through the 271/2

level in February to about the 291/2 level. F

Now suppose prior to the mid-July 1997 downmove,

investors who had bought stock at levels below 30 took profit
H
and sold to new investors at about 30. Many of these new
owners will be quite perturbed to see a loss of about 15% of A B C DE
their investment virtually overnight, and look for a rally in I
prices to get out with only a moderate loss.
On the other hand, investors who missed the prior rally G
might view this as an excellent buying opportunity, as the
stock was at 30 just two days ago; so the price rebounds as
people buy the dip. As the price once again approaches the
271/2 level (point A), the owners of the stock at 30 have
reduced their loss by 21/2 points and many place sell orders,
driving the price down again. This process is repeated (B and
C) until no significant numbers of sellers are left at this level, FIGURE 3: OUTBACK STEAKHOUSE. A trendline drawn from the lowest low (point
and the stock finally breaks through the 271/2 level in Febru- G) to the minor low (E) preceding the highest high (F) shows this diagonal line
ary 1998 after a three-day pause. exhibiting support until the trend is broken at H, and support is broken at I.
At this point, there are probably still some buyers of the
stock at 30 unwilling to take a 21/2-point loss and, as the stock
rallies to about 291/2, are feeling good about their decision to most of July, prices rise to a high of about the 41 level (F),
hold on. As the price weakens, some of these market partici- and then fall quite rapidly to below the 341/2 support line by
pants get nervous and call their brokers with sell orders, the first part of August, closing at a price of about 321/2.
driving the stock down to just above the 271/2 level (point D).
This happens a couple of more times (E and F) until all the
alarmed buyers willing to take a small loss are out, and the
The measure of significance and
price moves up through the 30 price level in May 1998. future reliability of lines in technical
This same process occurs not only at these prices but also analysis is directly related to the
at each price at which the stock trades, and — even though number of times that prices touch
this is an oversimplification — it is this type of investor
decision-making that helps establish significant support and
that line and then reverse.
resistance levels. Some overriding factor could influence the
stock’s price action, but in the absence of stronger factors, As point F is the highest high in our period being consid-
these levels can have a pronounced effect on the appearance ered (Figure 3), let us draw a trendline from point G to E and
of the stock’s daily chart. More important, by combining our extend the line to the right. Note that the close (H) prior to the
knowledge of past support and resistance levels with other one-day fall from 36 to a close of 321/2 (I) rests right on the
technical analysis and fundamental tools, we can be better trendline. The next day, the relatively big drop gives the
prepared to take advantage of price movement if we antici-
pate that movement, rather than be taken by surprise.
F

ANOTHER EXAMPLE H
Figure 2, which shows the daily
A B CDE
chart of Outback Steakhouse
I
[OSSI], is another good example
of a price level acting first as
G
support and later as resistance.
From the beginning of 1998,
the price of this stock moves
from about 281/2 up to 341/2 by
mid-February (point A). Take
note of the small congestion area sitting just above the
support line drawn at the 341/2 level, and the fluctuation of
FIGURE 4: OUTBACK STEAKHOUSE. Testing of the 34 1/2 price level after July (I)
prices over the next few months as prices rise and fall and is done from the opposite direction than at points A-E and is now acting as
test the 341/2 support line at B, C, D, and E. From E through resistance to upward price moves.

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V17:1 (55-58): Support And Resistance by Stuart Evens

impression that the trendline acted as support, and once

through this barrier, prices fall quite freely. This illustrates F

that support and resistance do not have to be horizontal but

can run diagonally, and in fact, trendlines themselves can be
thought of as support (uptrends) or resistance (downtrends).
H
In addition, chart patterns such as triangles, pennants, and so A B C DE J
forth, which we will discuss in another article, are formed by I
diagonal support lines.
Remember we spoke earlier of testing support at points A-
G
E? Now that prices have fallen below this level, we can say
the stock has broken support at 341/2 in addition to breaking
the trendline drawn through G and E (Figure 4). Prices spend
most of the month of August testing the same level (341/2),
except this time from the other direction. The line, no longer
acting as support, has reversed its role and is now acting as
resistance until prices move lower. By September, prices FIGURE 5: OUTBACK STEAKHOUSE. The new downtrend line is drawn from points
trade at about 26. F through J, since prices have broken the uptrend line. A line parallel to the new
The measure of significance and future reliability of lines in trendline is drawn through I.
technical analysis is directly related to the number of times that
prices touch that line and then reverse. If we count the times this will have on prices. Depending upon the number of reversals
has happened to our support/resistance line in Figure 4, we associated with a particular support or resistance level, more
come up with at least seven. This relatively large number of or less confidence can be placed in their importance.
reversals indicates that the line is very significant and could be
reliable in predicting future reversals. Will it be 100% reliable? Stuart Evens is a Staff Writer for STOCKS & COMMODITIES.
No, but the next time prices approach 341/2, there appears to be
a better chance than not that a reversal could occur. RELATED READING
Let’s take one more look at the chart of Outback Steakhouse Edwards, Robert D., and John Magee [1997]. Technical
(Figure 5), and consider the breaking of the trendline (point Analysis Of Stock Trends, 7th ed., AMACOM.
H) to close at 321/2 (I). Since prices seem not to be following Murphy, John J. [1986]. Technical Analysis Of The Futures
our uptrend, we would like to have another trendline to give Market, New York Institute of Finance.
the general direction of prices. A line drawn from points F
†See Traders’ Glossary for definition S&C
through J and extended down to the right is our new downtrend
line. A line drawn through H, parallel to the new trendline,
seems to encapsulate well the price action from July through
September. Prices seem to flow along, bumping into the walls
of the channel formed by these two parallel lines, which is
another example of diagonal support and resistance.

CONCLUSIONS
So what good are all these lines that we have drawn on our
charts? One way to help answer this question is to acknowl-
edge what they will not do. Support and resistance lines are
not 100% accurate predictors of when and where prices will
rebound. These lines are tools that can be used to alert the
trader to areas that need a closer examination. By using these
and other indicators, we can decide what, if any, impact they

Copyright (c) Technical Analysis Inc.

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