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Browse Topics:    Trading Strategies    Research & Analyze    

Using Support and Resistance to Gauge Price Ceilings and Floors

Learn how price ceilings and floors—also known as support and resistance lines—can help you spot emerging trends.

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The simple act of drawing a horizontal line on a price chart can at times provide a trader with a great deal of useful information. These horizontal lines, known as support and resistance lines or price floors and price ceilings, often mark important price levels. Price movement that touches or breaks through these lines can often highlight new emerging trends, and can offer clues as to which direction the price of a given security may move next. Support and resistance lines can prove especially useful during sideways trending markets.

Support Line
A support level—identified by drawing a line sideways across a price chart—highlights a price level where price previously stopped falling. In other words, it represents a price area at which there was previously enough buying interest to keep the stock or asset from falling any further. In most basic terms, a support level identifies at least a temporary "floor" under the stock or asset price.

Using Support and Resistance to Gauge Price Ceilings and Floors
Figure 1: Example of support

Once a support level is established, a trader can watch future price action relative to that support line for important clues. Essentially one of three things can happen:
1. Price remains above support.
2. Price retests support but does not break down through it.
3. Price breaks down below through support.

Each of these possibilities offers important information. For example:
• As long as price remains above the support level, one can argue that the downtrend that led up to that point has ended (at least for the time being).
• The more times that price comes down and successfully touches or nears the support level, the "stronger" and more significant the support level is considered to be.
• A price break below an existing support level indicates that a new downtrend may be beginning.

Traders generally use support levels as:
• Entry points for long positions if support is tested and holds.
• Exit points for long positions if support fails, meaning that the price falls below support.
• Entry points for short positions if support fails.

One method that some traders use to take advantage of "support" is to wait for price to retest the line but fail to break through to the downside. This successful test of the support trend line can often be followed by an advance in price. As a result of this not uncommon phenomenon, many traders will watch carefully for potential buying opportunities when a stock or asset trades near an established support trend line.

Very often traders will use a breakdown by price through a support level as a trigger to exit an existing position. In essence, the support level serves as something of a "line in the sand". If that line is crossed, the thinking goes, a different course of action is in order.

Similarly, traders who are willing to enter a short position may use a breakdown by price through a support level as a trigger to sell short the stock or asset in question.

Resistance Line
A resistance level—also identified by drawing a line sideways across a price chart—highlights a price level where price previously stopped rising. In other words, it represents a price area at which there was previously enough selling interest—and/or a lack of buying interest—to keep the stock or asset from rising any further. In most basic terms, a resistance level identifies at least a temporary "ceiling" above the stock or asset price.

Using Support and Resistance to Gauge Price Ceilings and Floors
Figure 2: Example of resistance

Once a resistance level is established, a trader can watch future price action relative to that resistance line for important clues. Essentially one of three things can happen:
1. Price remains below resistance.
2. Price retests resistance but does not break out above it.
3. Price breaks out above resistance.

Each of these possibilities offers important information. For example:
• As long as price remains below the resistance level one can argue that the uptrend that led up to that point has ended (at least for the time being).
• The more times that price rallies up to but fails to break through the resistance level, the “stronger” and more significant the resistance level is considered to be.
• A price break above an existing resistance level indicates that a new uptrend may be beginning.

Traders generally use resistance levels as:
• Entry points for short positions if resistance is tested and holds.
• Exit points for short positions if resistance fails, meaning that the price moves above resistance.
• Entry points for long positions if resistance fails (in other words, if price breaks out to a new high).

One method that some traders use to take advantage of “resistance” is to wait for price to retest the line but fail to break through to the upside. This test of the resistance trend line that sees price fail to break through to the upside will often be followed by a decline in price. As a result of this not uncommon phenomenon, many traders who are willing to consider entering a short position will watch carefully for potential short-selling opportunities when a stock or asset trades near an established resistance trend line.

Very often traders will use a breakout by price up through a resistance level as a trigger to exit an existing short position. In essence the resistance level serves as something of a “line in the sand.” If that line is crossed, the thinking goes, a different course of action is in order.
Similarly, many traders may use a breakout by price through a resistance level as a sign that the security in question is ready to move to higher ground and as a trigger to buy the stock or asset in question.

Summary
Support and resistance levels are typically thought of as a potential “floor” or “ceiling,” respectively, for a stock or asset. Once a price floor or ceiling is established it may be viewed by traders as a “line in the sand.” As price approaches this line, many traders pay close attention to what happens next and develop contingency plans regarding the actions they will take depending on whether or not the support or resistance line in questions holds or is broken.

Finally, support and resistance can be used as one part of the weight of evidence in making decisions about both opening and closing positions.

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