Support and resistance are the actual outcome, or the result of, the interaction between fear and greed and supply and demand. Understanding how they all work together is like watching a magnificent, orchestrated dance. It also gives you a giant advantage for making money.

As you read, keep this statement in the forefront of your mind: for every action, there is a reaction.

Support and resistance will form the foundation for every trading decision. You can trade without oscillators and indicators and moving averages. You can even eliminate charts altogether from your financial decisions (although I wouldn't recommend it). But even floor traders in commodities pits who rarely see a chart will mentally compute where price resistance and support lie, even as they shout and use hand signals (called „open outcry“) to get their orders filled.

The concept behind support and resistance is a simple one, and once you digest it, you will have absorbed the basic premise underlying market moves.

Picture this: You're standing in the living room of a house, on the first floor. In your hands, you hold a ball. This ball equals the price of a stock. You toss the ball over your head. It soars upward, and hits the ceiling. The ceiling keeps it from rising higher, so the ceiling equals resistance. Now, the ball falls back down and bounces on the floor. The floor stops it from falling further, so the floor equals support.

Next, you spot a hole in the ceiling. You throw the ball as hard as you can, and it flies through the hole in the ceiling. It rises to the second-story ceiling and hits it. That ceiling equals resistance. Then, the ball falls to bounce on the second-story floor, which now forms support. Understand that the first-story ceiling supports the second-story floor. Result? Resistance becomes support.

Continue by running upstairs and grabbing the ball. Throw it back through the hole, down into the first-story living room. When it drops through the hole in the floor, it breaks through support. It falls to bounce on the living room floor, or previous support.

Then, it rises to hit the ceiling, or previous resistance. Run back down the stairs. Take the ball and toss it through a hole in the floor. The ball descends to the basement floor, which forms support. Then, it rises to bounce off the basement ceiling, resistance. Just above the basement is the living room floor, which uses to provide support. So now, previous support forms resistance.

The below figure illustrates support and resistance.

When the ball, which we'll now think of as a stock price, bounces off of support or resistance, we refer to it as a pivot point, which is illistrated in the below figure.

As you study support and resistance, remember, they are price areas. You will have to find a specific price to refer to, for example $54, but give it a little leeway. Picture yourself jumping on a trampoline. The trampolin.e supports you when you land on it, but the depth of your bounce varies a little each time. Also, just as heavier people stretch the trampoline base lower when they land, more volatile stocks need a little extra latitude in theif resistance and support areas.

Since you now know what support and resistance look like, let's quickly find out how they actually form. Go back to imagining the ball bouncing from floor to ceiling in the basement. Now, apply that to a stock in a Stage One, or basing price pattern. The basement floor is support, and we call it that because buyers are supporting the price. Were it to start lower, buyers (greed + demand) step in and accumulate, thus keeping the price from sinking lower.

When the price rises to the basement ceiling, it hits resistance. Resistance equals buyers who jam their hands in their pockets and refuse to pay a higher price for the stock. Also, resistance equals supply. At this point, some previous buyers, as mentioned before, revert into sellers. Afraid (fear) the stock will rise no higher, they offer their stock for sale, thus flooding the market with supply. If the stock falls here, the next time it rises to return to this price area, it may sell off again. Why? Because we have memories!

Say the stock shoots through the resistance (supply is absorbed). Maybe the sector it inhabits is in a favorable spotlight, the bulls are in control of the market, or the company itself enjoys a spurt of good news. The price will continue to rocket-maybe for hours or days-until a new factor suppresses it. When it „sells off,“ that pivot point creates fresh resistance. The stock then falls to the earlier resistance area, which is now the „floor,“ or support. It will hold there if buyers absorb the supply, and in so doing, „support“ it.

Support and resistance levels apply on every chart you'll ever see, whatever the time frame. In fact, you may have guessed by now that all the applications you'll learn about charts hold true on all time frames. That means the concepts you find in these pages pertain not only to swing-and-position trading, but also to strategies including active trading and traditional buy-and-hold investing.

The below figures show support and resistance areas on a weekly chart, a daily chart, and a fifteen-minute intra-day chart. As you study these charts and observe support and resistance levels, you may be amazed athow reliable they are!

I'll now show you what I mean by „natural“ support and resistance. Let's look at a nicely trending market in Crude Oil.

Natural support and resistance points are those places in a trend where prices either move sideways for a brief period or where prices make some sort of correction by moving counter-trend for a few bars.

These stops usually work because price action in the market has previously held at those levels. If recent price was too high or too low at that level, then price will probably be considered too high or too low at that level in the near future. These stops take advantage of the natural support and resistance in the market.

If prices at a natural point of resistance or support do not hold, then the probabilities are that we have been wrong fn our estimation of market action, and we are better off being stopped out of the trade.

I have a tendency to use natural support and resistance points when planning a longer term trade for the time frame fn which I'm trading. The next chart will illustrate this concept. The main thing is to set the stop in light of my objectives and strategy.

On the chart below, we see major basing action by March Soybeans. If I were anticipating a long term trade, I would want to place my stop below a natural support point as opposed to perhaps a step based upon market voatility. If I were anticipating a short term trade, I would use market volatility as opposed to a natural support point. Mу stop placement should reflect my trading objectives and strategy.

Advantages and Disadvantages of Natural Stops

The single greatest disadvantage to using natural stops is at one and the same time its greatest advantage: Prices may be too far removed from the current price action.

Natural stops are easy to see on a chart once prices move away from them, and in a trending market prove to be remarkably safe. They tend to keep you in a trade for a long time.

A big disadvantage to using natural stops is that at times, when you wait until they are hit, you may see a rather nice gain turn into a loss. Natural stops are of little or no use in non-trending markets.

The next chart gives you an idea of what I mean when I say a natural support point may be too far removed from the current price action.

Anticipating a bull move in Corn, technically supported by the strong basing action on the chart, I would want to use a natural support point. However, if I took the most natural support point, I would have a stop substantially away from current prices. I've shown the alternative stop placement point I would have used.

Know where the price support and resistance areas are on a chart. These are areas that have halted the movement of the stock in the past. The more times a particular price has stalled the stock's movement, the stronger that support or resistance area becomes. Price support lines can be drawn horizontally through lows on a bar chart where price tended to bounce up. Thus this price level is „supporting“ the stock. Price resistance lines can be drawn horizontally through highs on a chart which the stock: resists moving up through. Very often you will find that a support area which the stock penetrates to the downside will become a resistance area in the future. And likewise, a resistance area that a stock finally penetrates to the upside becomes a support area in the future.

The daily chart's support and resistance areas will help you better decide whether a trade setup is worth entering. If there is a lot of resistance just above where you would buy the stock, then you may want to pass up the trade. On the other hand, if a price resistance area is being broken or has recently been broken through to the upside, a buy trade setup has a better chance of success with the stock moving up further. Look for these areas on the daily and intraday charts to find the nearest upside resistance level up if you are buying or the next support level down if you are selling. If there is enough room for a 1 + point move, you have enhanced the odds for a successful day trade. Also, if the daily chart shows good support at a price level, and you have a „wide range bar w/extreme close“ or a „reversal bar“ setup long that held at a pnee support area, then this might present a strong buying opportunity. Remember not to impose your ideas on the market, but instead reacE to what it tells you with tiie daily and mtraday setup patterns. The S/R. levels will kelp you find the best trades to enter.

„Trading congestion“ is something to stay away from. If a stock is not trending, has narrow range daily bars (from high to low), or is just chopping sideways, then avoid it. Wait until it breaks out of congestion and begins some good daily price swing activity. This is when you look for the trade setups to act upon. Also, look at the recent average range of a daily price bar (from high to low). If that stock doesn't trade over a point or more on a regular basis then you probably won't want to trade it. Look for the bigger profit opportunities with stocks that are currently in a „trader-friendly“ mode.

You'll also notice that many times the 50 and 200 day moving averages act as price support and resistance. This is because many fund managers monitor these averages and use them in their buying and selling decisions. Being aware of where these lines are can aid your analysis. This is especially true if a stock has traded up or down to one of these averages at a point which also coincides with a price support or resistance level.

Support and resistance levels aid your decision making for day trades. They show how far a stock can be expected to move up or down on both an intraday and daily time frame. This is the final step (or filter) to confirm a potential trade, or to rule it out.

March, 2004

The following shows a brief overview of shorting signals in a downtrend. The setups resemble buying signals in an uptrend. There are, however, subtle differences. The below figure illustrates three key shorting signals.

Read them like this:

1. The breakdown from support.
2. The breakdown after the stock rebounds to resistance (supply), then drops back into its downtrend.
3. The add-to-position point for position traders. Here, the price collapses below the previous pivot low, or support.