Understanding Support and Resistance

Understanding Support and Resistance

December 18, 2017 Off By Chuck

One of the most basic (and important) elements of Technical Analysis is support and resistance. They represent key junctures where the forces of supply and demand meet. In the financial markets, prices are driven by excessive supply (down) and demand (up). Supply is synonymous with bearishness and selling. Demand is synonymous with bullishness and buying. As demand increases, prices advance and as supply decreases, prices decline. When supply and demand are equal, prices move sideways (consolidate) as bulls and bears slug it out for control.

Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further.

Support is the price level at which demand is thought to be strong enough to prevent the price from declining further.

Taking a look at a post I made back in July of this year regarding Grainger, GWW, the chart illustrates that price was approaching a prior level of support.  As such, I was expecting it to find a bottom and experience at minimum, a reversion to the mean bounce. Additionally, momentum would likely form positive divergence and be the wind behind any bounce. July’s chart is below

San Rmaon independent fee only investment management CFP - retirement planner GWW 1 - 12-18-17.png

Fast forward 5 months ahead to now, taking a look at the same chart of Grainger updated with recent action we can see how price did find that bottom, it also formed positive RSI divergence and provided a very nice tradeable bounce opportunity.

Bay area triv-valley San Rmaon independent fee only investment management CFP - retirement planner 12-18-17 GWW 2.png

In this case, GWW actually provided something much more than a tradeable bounce as it has  gained more than 50% from the July bottom. Identification of key support and resistance levels is an essential ingredient to successful technical analysis. Even though it is sometimes difficult to establish exact support and resistance levels, being aware of their existence and location can greatly enhance analysis and forecasting abilities. If a security is approaching an important support level, it can serve as an alert to be extra vigilant in looking for signs of increased buying pressure and a potential reversal. If a security is approaching a resistance level, it can act as an alert to look for signs of increased selling pressure and potential reversal. The bottom line is if a support or resistance level is broken, it signals that the relationship between supply and demand has changed. A resistance breakout signals that demand (bulls) has gained the upper hand and a support break signals that supply (bears) has won the battle