Probably the most fundamental technical analysis technique when trading stocks and options is the ability to find support and resistance on a stock chart.
Simply put support and resistance are levels on a chart are areas where price has reacted in the past and can potentially react to again in the future.
Now why would we want to attempt to draw-in support and resistance levels on a stock chart? These support and resistance levels can show where possible trade opportunities will arise as many stocks will either rise from or stall-out at these levels.
There are specific criteria you can look for when attempting to define support and resistance levels:
- Swing Highs & Swing Lows
We look for the extreme swing highs and swing lows that price has reached in recent time.
- Look for multiple price rejections of an area. The more the better. A price rejection is where a price reaches a certain level on the upside, but never significantly higher.
- The Level Should Be Obvious – It should jump right out at you. You should be able to spot the level right away when looking at a chart.
- The Move Away Was Drastic. When the price hit the support or resistance level, the move away from that level was drastic in the opposite direction.
- The Level Has Acted as Both Support And Resistance. The level has been respected from both sides.
- The Level was recently respected or formed in a recent time period.
You do not need all of the above 6 criteria to make a level “support” or “resistance”, however, the more traits the level has, the better.
Let’s look at a few charts to supplement our 6 traits of support and resistance:
Trait #1: Extreme Swing Highs and Swing Lows
Below is a chart of Tyson Foods (TSN) You can see a well-formed level of resistance at around the $84 level. Price climbed up to this level and reached it, but did not go higher. The stock has a massive move from $49 to $84 over the course of 6 months.
Trait #2: Multiple Price Rejections
The below chart is of Salesforce (CRM). You’ll notice that the stock went up to around the $167 level multiple times, and each time came back down sharply.
Trait #3 The Level Should Be Obvious
As in the two examples above, there is a well-defined line where can easily spot the level where the stock reaches and then comes back down (or back up). In this example of Advanced Auto Parts, we see a well-defined level of support at $156. The stock hit that level multiple times while never going below.
Trait #4 – The Move Away Was Drastic
The chart below of Dollar Tree illustrates a drastice move away from resistance. DLTR hits the 113-114 range and then takes a sharp drop.
Trait #5 – The Level Has Acted as Both Support And Resistance
This chart of Amazon, we can see the $1700 level has acted as both support and resistance.
Trait #6 – The Level Was Recently Respected or Formed In A Recent Time Period
In this chart of AVGO, we can see the price running into a possible resistance level. We’d watch this closely to see if it breaks through or begins to sharply pull-back.