Charts Analysis: The concept of support and resistance levels isonline stock trading extremely interesting, and one which will help you considerably in the timing of your online trading decisions. Yet it is a very simple concept to grasp.
Support and resistance are basic tools used by online traders to identify key reversal areas on charts for their charts analysis. As the names suggest support acts to keep the price above a certain level, whilst resistance acts to keep a share’s price below a certain level. Drawing support and resistance lines on charts, allows us not only to analyse where these levels are, but also to consider future price movement in relation to them. Oh, and don’t worry, all charting packages have the facility to draw lines on the screen. Before I show you an example on a stock chart, let me try to explain why these levels arise in the first place, and then we will look at how to use them to advantage in timing your trading decisions.
Charts Analysis – Support and Resistance Levels Explained
Imagine a stock price is moving up and then subsequently starts moving down again. At the turning point there will be many buyers trapped who did not sell before prices moved down, and have decided to wait until the price moves back up again before selling ( they are living in hope ! ) Let us assume now that the stock price has stopped falling, and has started rising again. As it nears the point at which it turned the first time, those trapped buyers breath a sigh of relief and sell at breakeven or slightly less, which forces the price back down again as there is now more selling pressure than buying pressure. Naturally in the up move there has been buying, and these buyers now become trapped as prices move back down again. Now this can be repeated many times over, and you will see many different instruments including shares that behave in this way. In some cases this price action can last days, weeks or even months. This is a key area for your charts analysis.
At the point where stock prices were falling and then started rising, exactly the same thing is occurring, but in reverse of course. We now have short sellers who are trapped at the bottom and have to wait for the price to come back down to them, who gratefully close their positions when this happens, to be replaced by more short sellers who are then trapped in turn….. – I think you get the picture.!! When this price action happens, it has several consequences. Firstly it produces what we call a channel and the instrument is said to be channelling( or range trading ). The prices form a defined channel with two lines that can be drawn, one above, and one below. Now the important part for us is not to practice our drawing skills, but these lines actually help us considerably. Once one of these levels is penetrated by prices, it becomes a level of support ( for prices going up ) and a level of resistance for prices going down.
Let’s imagine we have been watching a stock chart for some months which has been trading within a channel. Suddenly we notice one day that it has broken above the level and prices are now moving up. The line that was originally resistance to higher prices, has now become a level of support and we can trade with more confidence, knowing that if the prices are going to go back down again they will have to penetrate this line of support or floor if you like. If you imagine a building with two floors, prices have moved from the ground floor through to the first floor, and what was the ceiling, has now become the floor. In other words it has become a SUPPORT to higher prices and will take effort to penetrate if prices fall back. It gives us a little more comfort ( but not too much ) in now buying into the move.
To use the house analogy again for the prices at the bottom of the channel. Suppose we notice one day that prices have gone through the ground floor and into the basement, what was the floor has now become the ceiling and has become RESISTANCE to prices going back up to ground floor level. OK – let’s look at a couple of examples which I hope will give you the general idea:
online stock chartThe stock chart on the left is for GUS ( Great Universal Stores ) a constituent of the FTSE100 on the London Stock Exchange. As you can see, prices traded within a range from £7 to £8 approximately for almost 7 months from Oct to May. In order to draw our channel I have simply joined the tops with the blue line, and the bottom with the yellow line. In order to draw meaningful lines one should have a minimum of three points as shown above. On the blue line we have three points, and on the yellow line we have four. Please don’t try to look for exact touching points for the line, this is an approximation only, and you should be able to see trending prices just by a quick glance at the chart – if you can’t then it probably isn’t a channel. The lines simply reinforce the points and you can leave the lines on the chart for reference over the next few weeks as you put this share on your watch list.
Up until May we have no idea whether the price was going to break to the up side or the down side – so we wait – yes you have to be patient to make money!!!!! Once the price ‘breaks out’ of the channel we can see it has broken to the up side so we expect higher prices. DO NOT rush in on the first bar that breaks the blue line – wait and see for a few days until you can see some daylight above the blue line – then go in. Now whereas the blue line was acting as resistance to higher prices, now it is acting as a support. The ‘ceiling’ has become the ‘floor’, and if prices are to fall back down it will take effort to go back down and through into the channel again – hence we have a degree of comfort in opening the trade. Note that in the above, prices did indeed go back to the support line but bounced off and continued moving upwards. Something else you should have noted is the very large volume spike in May just before the breakout, followed by another later in early June. You would pay close attention to these bars and add this analysis into your decision. Do you see how all the tools start to fit together? Now lets look at another example.
online stock trading chartIn this example the price channelled between £34 and £26 for over a year! Eventually as we can see the prices broke to the downside through the yellow line which up until then had been acting as a support line. Once prices have broken through, this line then becomes resistance to prices coming back up again ( the floor becomes the ceiling ). Note the significant increase in volume as prices start to fall rapidly – this is a genuine move down with effort ( volume ) – ( wouldn’t it have been nice to be shorting the share as it fell from 26 to 22 in a day!! – of course, but we are not looking to pick tops and bottoms – we just follow, and go in once a move has been confirmed) One other point to note with the above, we would be analysing the increase in volume under the last top here – lots of effort ( volume ) and no increase in prices is suspicious so hopefully we would have been expecting something to happen and had this share on our watch list.
Now, one final point on support and resistance and then we’ll move on ( not more I hear you say!) – I never said this was a get rich quick site – take it slowly there is no need to rush, the markets will always be there today, next week, next year or whenever you are ready – just take your time. ( lecture over ) Right, the last point on this topic. You may remember from an earlier page I mentioned ‘ gapping up’ and ‘gapping down’. This occurs when the opening price the following day, has opened at a different price from that which it closed at the night before. Probably easier with a simple diagram :
Gapping up, is as shown to the right in this simple diagram wherestock chart candle the opening price is higher than the previous closing price. Gapping down is the exact opposite in a down move where the opening price the following day is lower than the closing price the night before. Now the reason I mention it in the context of support and resistance is simply this – if prices break out of a channel with a gap up ( going up ) or a gap down ( going down ) this adds weight to the move and weight to your decision to trade. The reason the gap has formed is because the market makers have opened prices with a significant gap ( up or down ) – they have done this for a reason. If it also coincides with a break out from a channel you can be reasonably sure that this confirms the move and therefore has more significance. Look out for them, gapping up or down through support and resistance levels online can be worth the wait!!
Now we are going to look at the last piece of trading information that we have on our charts – simple moving averages – then that’s it for online chart reading and charts analysis.