Another Look at Support and Resistance

Areas of support and resistance form through the normal price action of buying & selling. Buyers who enter at one point either look to exit the trade for a profit as prices rise or breakeven if the market falls while they still hold shares.

A buyer who purchases a stock at $30 will hold that play until prices stall or reverse. Once the sale is made, someone else owns the shares at the highest price traded. This buyer is looking to exit at the first chance possible to at least recover the investment. Such behavior creates overhead resistance.

On the other hand, buyers that bought back at $30 and sold higher are happy to repeat the process. Each time the equity returns near that level they will buy the stock and wait for prices to rise once again. This creates underlying support.

News and corporate events along with numerous other factors help push prices above resistance to new highs or below support to new lows. Such price action dynamics are clearly illustrated on long-term charts:

(Daily chart of RMBS)

Clearly we can see where buyers and sellers from weeks & months past react as their "mental targets" of profit or recovery are reached. Stock prices will test these levels numerous times before the majority of the buying and selling clears.

(Daily chart of RMBS)

Investors and traders watch these key points of price action to enter and exit trades accordingly. Natural market rhythms keep prices above near-term moving averages during rallies and below them at downturns. Savvy traders capitalize when price action meets these important points of support or resistance.

(Hourly chart of RMBS)

Once we've determined our stock has neared a key entry point on the daily charts, we can switch to hourly charts and wait for prices to clear resistance. Note the solid support given at moving averages as prices tested resistance several times and cleared for the next move up.

Buying on pullbacks to the moving averages as they rise give us excellent entries for profit potential. Likewise, entry at levels of support tested and held three times or more offer solid entries to trade.

Waiting for trade entries to develop near key areas of support and resistance is imperative to trading success.