This is probably the most important and hardest concept for people to get used to. It's easy to understand but utilizing it is usually hard for most people because they don't want to believe their eyes.
What is Resistance and Support?
Imagine you have a ladder in your house that is in between your floor and ceiling. Your ceiling would be considered resistance and your floor would be considered support. Now just imagine you are the price of a stock. Lets say you climb up the ladder as fast as you can, hit the ceiling (resistance), and fall back to the floor(support). You get up and keep trying until you build up enough momentum to "breakout" of the resistance level or you fall and "breakdown" below the support level. This is what resistance and support is for a stock. It is a range where a stock can stay for a long time until it breaks out or down. All stocks have resistance and support areas and knowing where they are can help us trade with assurance and safety. These areas are used to set stop losses and as a way to enter a stock safely. For example, if a trader gets bearish signals from a number of indicators and the stock in question is near a support level, then the trader will short the stock and place a cover limit a little above the support level. This is because we know that if the stock falls below the support level then it will continue to fall.
In the DELL chart above the resistance is at 24 and the support is at 18. Notice how the stock trades in this range for an extended period of time(Jan 08-Sep 08). It broke out of the resistance level of 24 for almost the entire month of August but then began to fail. Technicians would place an order to short the stock a little below the resistance level because once that level is breached the stock will trade in the range of 24 and 18. Notice how once the resistance level was broken the stock fell to the support level. Once the stock moves close to the 18 support level technicians take a wait and see attitude. We wait to see if it will break the 18 level while paying close attention to other indicators to make sure the bearish trend is still intact. Once it breaches the support level we hold the short until the next support level is reached. If it turns bullish then we cover.
The resistance and support areas are outlined in the chart of RIO above. Being long on this stock a Technician would try to buy as close to the support level of 10 dollars as possible knowing that it would be hard for the stock to fall through this level. Once you have entered as low as possible you would put a stop limit in a little below $10 maybe at $9.60. As the stock moves up you take a wait and see attitude when it approaches the $20 resistance level. If it breaks that level you hold and place a new stop limit a little below $20. In this example the stock did not retrace below the $20 level. In fact, it continued to rise all the way to $30 before it pulled back a little and broke below the $30 resistance/support level. If you would have held this stock and followed the advice of moving your stop limit up as the stock crosses resistance levels you would have had a gain of 200%.Like everything else it takes time for your eyes to get used to seeing resistance and support levels. Practice as much as possible in order to get used to seeing them. You can also check nasdaq.com. They have something called a stock consultant on their site that will show you resistance and support levels for any stock.
Note: Once a stock crosses above a resistance level, that resistance level becomes the new support level.
