CHARTING
Does Support And Resistance Work?
Predicting Prices With Support And Resistance
by Thomas N. Bulkowski
I consider support and resistance (SAR) the most important chart patterns. Why? By finding SAR, you can predict how far prices might climb and how far they might fall before you trade. Isn't that worth something? That's like a blackjack dealer sneaking a peek at the top card in the deck and telling you to take it because you'll win. Is he pulling your leg? Does support and resistance work? Let's find out.
First, some definitions. Support occurs when increased demand for a security builds a floor under prices. A support level or zone appears when buyers miss purchasing a stock and vow to buy it should prices decline to the same, or nearly the same, level.
Resistance occurs when selling pressure stops a price rise. A resistance level is similar in that traders buy the security just before it tumbles and they vow to sell if prices reach their purchase price. How many times have you heard novice traders say, "As soon as I get my money back, I'm selling"?
SAR comes in many flavors, and I'll discuss the most important ones.
ROUND NUMBER SAR
Round number support and resistance is just what it sounds like. Prices pause at common buy or sell prices. Figure 1 shows an example of prices pausing near 20 through 70 in increments of 10. Why buy a stock at 9.85 or 10.23? Most traders place buy or sell orders at even 10 intervals, as you can see, creating round-number SAR.
Figure 1 shows how resistance at point A, where prices stall, becomes support at point B, when prices dip to 20 then rebound. The six points at C show how the 30 level is not a point but a range - an area of support. When prices close in on 30, traders buy or sell and hope for the best. The three D points show how a support area becomes a future zone of resistance.
Look how often prices miss the round number. By that, I mean prices don't stop at 30 (C); they stop slightly above or below it. Recognize that you are working not with one price, but with a zone of prices as you place buy or sell orders at round numbers - your orders might not be hit. That's worth knowing if you want to place a stop-loss order. Don't place it at 30. Everyone else is going to place it there, and if you want to beat the crowd, put it slightly above so you aren't caught in what's referred to as stop-running or stop-gunning. That's when a series of stop-loss orders are executed and prices tumble, setting off more stops in a cascade.
Figure 1: Round number support and resistance. The letters represent key SAR points. Note how a support area later becomes a resistance area (A and B, D) or vice versa.
...Continued in the October 2003 issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the October 2003 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2003, Technical Analysis, Inc.
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