How to Properly Identify Support and Resistance Levels
Make no mistake, technical analysis is just as important as fundamental analysis, and some of the most influential traders in history have made fortunes by proprely applying technical analysis in their trading methodologies.
Let's take a look at how technicians have learned from Jesse Livermore:
“The price pattern reminds you that every movement of importance is but a repetition of similar price movements, that just as soon as you can familiarize yourself with the actions of the past, you will be able to anticipate and act correctly and profitably upon forthcoming movements.”
William Gann – known for Gann angles -- was a technical trader, making $50 million from the markets. Billionaire Paul Tudor Jones of Tudor Investment Corporation is a technician now worth billions.
Munehisa Homma – considered the father of the candlestick chart – was worth more than $100 million in today’s US dollars. Candlestick formations, such as the doji cross, the long-legged doji, the gravestone doji, the hammer, and the hanging man are used by technicians. They allow traders to identify the mood of the market or a stock.
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Two of the most basic technical patterns to master are support and resistance levels.
When looking at fear and greed on a chart, we begin to look at the technical parameters of support and resistance, or a price floor or ceiling, as we noted in our initial discussion on support and resistance lines.
When prices are falling to the floor, support represents the moment when buying begins to overwhelm selling and prices begin to bounce back. Conversely, when prices move to the ceiling, resistance is the point where selling begins to overwhelm buying and price increases begin to reverse.
You can identify support and resistance by studying charts.
Look for a series of low points when a stock continues to fall to a certain level, but then doesn’t fall any more. Typically this is support. And when you find a stock that rises to a certain high, but rises no more, you have found resistance points.
The more times a stock bounce off support and resistance, the stronger these support and resistance lines become for technical analysis. If something repeats itself again and again, it becomes a stronger indicator of potential pivots at high or low points on a chart.
Two ways to find great support and resistance is through the identification of double tops and bottoms, for example. If your stocks bounces off the same support level, or fails at the same resistance level at least twice, we can make an argument for selling or buying said asset at each pivot point.
When it comes to double tops, these can typically be found at the peak of an upward trend, and can oftentimes be a signal that the prior upward move is beginning to weaken with buyers losing interest.
A double bottom on the other hand is the opposite.
It can signal the reversal of downtrend, and begin to show us strength after an asset pulls back. Once double bottom is proven to hold, an argument can be made for a potential reversal to the upside.
If you can identify such patterns you increase your odds of success.
Let’s look at a quick example using a six-month chart of NVIDIA (NVDA) – one of the hottest stocks on the market over the last two years.
- On November 27,2017, the stock attempted to break above double top resistance. Unfortunately, it failed at resistance and pulled back. Any one that spotted that double top could have either shorted the stock on the failure, or sold their shares if they were long.
- On December 14, 2017, the stock again began to pull back. However, on a slight pullback it managed to catch a support level that set up on December 5, 2017. By holding, we now had double bottom support and could begin to argue that the stock could be about to move higher from that point, which it did.
Granted, these are very simple explanations of support and resistance. We’d also want to confirm our findings with other indicators such as MACD, relative strength and W%R.
But remember, sometimes simplicity leads to the greatest of rewards.
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