Support & Resistance

Explore the fundamentals of support and resistance levels in stock chart analysis.

Support and Resistance—In Simple Words

Support and resistance levels represent key junctures where supply and demand meet. In the financial markets, prices are driven by excesses of supply (down) and demand (up). Supply is synonymous with bearish, bears, and selling. Demand is synonymous with bullish, bulls, and buying. These terms are used interchangeably throughout this and other articles. As demand increases, prices advance, and as supply increases, prices decline. When supply and demand are equal, prices move sideways as bulls and bears slug it out to gain control.

What Is Support?

Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.

Support does not always hold, however, and a break below support signals that the bears have won out over the bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive to buy. Support breaks and new lows signal that sellers have reduced their expectations and are willing sell at even lower prices. In addition, buyers could not be coerced into buying until prices declined below support or below the previous low. Once support is broken, another support level will have to be established at a lower level.

Where Is Support Established?

Support levels are usually below the current price, but it is not uncommon for a security to trade at or near support. As technical analysis is not an exact science, setting precise support levels can often be difficult. In addition, price movements can be volatile and briefly dip below support. For example, it does not seem logical to consider a support level broken if the price closes an eighth below the established support level. For this reason, some traders and investors establish support zones.

What Is Resistance?

Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. Logic dictates that, as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance.

Resistance does not always hold; a break above resistance signals that the bulls have won out over the bears. A break above resistance shows a new willingness to buy and/or a lack of incentive to sell. Resistance breaks and new highs indicate buyers have increased their expectations and are willing to buy at even higher prices. In addition, sellers could not be coerced into selling until prices rose above resistance or above the previous high. Once resistance is broken, another resistance level will have to be established at a higher level.

Where Is Resistance Established?

Resistance levels are usually above the current price, but it is not uncommon for a security to trade at or near resistance. In addition, price movements can be volatile and rise above resistance briefly. Sometimes it does not seem logical to consider a resistance level broken if the price closes 1/8 above the established resistance level. For this reason, some traders and investors establish resistance zones.

Methods to Establish Support and Resistance?

Support and resistance share enough common characteristics to be mirror images of each other.

Highs and Lows

Support can be established with the previous reaction lows, while resistance can be established by using the previous reaction highs.

The below chart of Halliburton (HAL) shows a large trading range between Dec-99 and Mar-00. Support was established with the October low around 31. In December, the stock returned to support in the mid-thirties and formed a low of around 33. Finally, in February, the stock again returned to the support scene and formed a low of around 32 1/2.

After each bounce off a support level, the stock traded up to resistance. Resistance was first established by the September support break at 42.5. After a support level is broken, it can turn into a resistance level. The stock advanced to the new support-turned-resistance level of around 42.5 from the October lows. The resistance level was confirmed when the stock failed to advance past 42.5. The stock traded up to 42.5 twice after that and failed to surpass resistance.

Support Equals Resistance

Another principle of technical analysis stipulates that support can turn into resistance and vice versa. Once the price breaks below a support level, the broken support level can turn into resistance. The break of support signals that the forces of supply have overcome the forces of demand. Therefore, if the price returns to this level, there is likely to be an increase in supply, hence resistance.

The other turn of the coin is resistance turning into support. As the price advances above resistance, it signals changes in supply and demand. The breakout above resistance proves that the forces of demand have overwhelmed the forces of supply; if the price returns to this level, demand will likely increase, and support will be found.

The NASDAQ 100 Index ($NDX) broke resistance at 935 in May-97 and traded just above this resistance level for over a month (see chart below). As the index remained above resistance, 935 was established as a new support level. The stock rose to 1150 but fell back to test support at 935. After the second test of support at 935, this level is well established.

In the chart below, you see that support can turn into resistance and then back into support. PeopleSoft found support at 18 from Oct-98 to Jan-99 (green oval) but broke below support in Mar-99 as the bears overpowered the bulls. When the stock rebounded (red oval), there was still overhead supply at 18, and resistance was met from Jun-99 to Oct-99.

Where does this overhead supply come from? Demand was obviously increasing around 18 from Oct-98 to Mar-99 (green oval). Therefore, there were a lot of bullish buyers of the stock around 18. When the price declined below 18 and fell to around 14, many of these (now unhappy) bulls were probably still holding the stock. This left a supply overhang (commonly known as resistance) around 18. When the stock rebounded to 18, many green-oval-bulls probably took the opportunity to sell and “escape” with little to no loss. When this supply was exhausted, the demand could overpower supply and advance above resistance at 18.

The Bottom Line

Identification of key support and resistance levels is an essential ingredient to successful technical analysis. Even though it's sometimes difficult to establish exact support and resistance levels, knowing 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 approaches a resistance level, it can act as an alert to signs of increased selling pressure and potential reversal. If a support or resistance level is broken, the relationship between supply and demand has changed. A resistance breakout signals that the bulls (demand) have gained the upper hand, and a support break signals that the bears (supply) have won the battle.

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