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Narrator: A stock's price rarely moves in a linear path; instead, it fluctuates up and down over time. However, when it repeatedly reaches a certain value then reverses direction, it creates price levels called support and resistance. These levels are just one tool in technical analysis that you can use to become a more skilled trader.
In this video, we'll discuss what support and resistance levels are, what causes these levels to occur, and how they can help identify buy and sell signals.
Simply put, support and resistance are price levels that act as boundaries that a stock has bounced off more than once.
Support is the level a stock tends to stay above. Think of it as the floor supporting the price.
And resistance is the level a stock hits and comes back from. Resistance levels act as the ceiling for prices.
Support and resistance levels are confirmed when a stock's price bounces off a certain value more than once; the more times this happens, the stronger the level is.
You might wonder what causes support and resistance to occur. There are several reasons.
On-screen text: Disclosure: Stocks trading involves high risks, and you can experience a significant loss of funds invested.
Narrator: When a stock price falls back to a previous low, investors might be more interested in buying—they're looking for a good price in hopes of buying low and selling high.
Likewise, when a stock's price approaches a previous high, investors might be more interested in selling and taking their profits.
On-screen text: Disclosure: For illustrative purposes only. Not a recommendation of any security or strategy.
Narrator: Another reason support and resistance levels exist is that money managers often have common price targets. This means it's common for a lot of stocks to be bought at a certain price and sold at another predetermined price.
Now that we know what causes support and resistance, let's learn how these levels can possibly help you make decisions when trading.
When the price hits a support or resistance level and then reverses direction, it's called a bounce. Therefore, when technicians see the price of a stock nearing support levels, it might be time for them to buy.
The more solid the support level is, the more confidence technicians might have it could bounce back up. On the other hand, if the price reaches resistance levels, some technicians may think it might be time to sell.
However, support and resistance levels aren't hard stops for prices. When a stock moves beyond previous limits, it's called a breakout.
If an upward-trending stock breaks resistance, the old resistance level often becomes the new support level.
After a breakout, technicians may see this as a good place to buy, believing the stock will rally and climb.
Depending on investors, and if they're bearish or bullish, support and resistance levels can be used in different ways.
An investor looking to build a position might watch support levels for buy signals, hoping the stock will rally and break through resistance.
An investor looking to close a position might watch resistance levels for sell signals.
How you use support and resistance levels as buy and sell signals depends on the type of investor you are. For example, very active investors, like swing traders, use these levels to buy and sell often, possibly even in the same day.
Less active trend traders can simply use breakouts to confirm a trend's direction.
Support and resistance are basic concepts of technical analysis. Some investors are comfortable making trading decisions using only support and resistance, while others prefer coupling it with other technical analysis tools and techniques.
Understanding support and resistance makes you better equipped to make sense of the market—no matter which way it's trending.
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