Trading Support and
Resistance
Bar and candlestick charts can help technicians identify buying and
selling opportunities, including those signaled by support and resistance.
Let’s define these entries and exits a little better; we’ll show how they
might become part of an investing plan later on. There are two types of
entries: bounces and breaks.
A bounce occurs when price meets support or resistance and rebounds
in the opposite direction.
A support bounce occurs in a series of bars at support. An acronym that
some find helpful when identifying a support bounce is CAHOLD, or
a Close Above the High Of the Low Day. The pattern first identifies the
bar with the lowest price in the series—this is the low day. Then, when a
bar has a closing price above the high of the low day, technical traders
would say it confirms the pattern.
When traders see an upward bounce like this, they expect price to rise.
Because of these expectations, this is an entry for bullish traders hoping
to profit from a stock’s gains. It’s an exit for bearish short sellers who’ve
profited from the stock’s losses.
The stock below had support at $24.50. Several times the price came
down to this level and bounced higher. The CAHOLD bounces were
complete when the stock closed higher than the low day.
A resistance bounce is similar, except it occurs at resistance. Consider
using this acronym when identifying a resistance bounce: CBLOHD, or
a Close Below the Low Of the High Day. This pattern identifies the bar
with the highest price in the series—this is the high day. Then, when a bar
has a closing price below the low of the high day, technical traders would
say it confirms the pattern.
When traders see a downward bounce like this, they expect price to fall.
This makes it an exit for bullish investors and an entry for bearish
investors.
Wynn Resorts LTD. (WYNN) was downtrending in 2014. In September it
moved sideways and created resistance at $190. In November the price
bounced off the resistance line, creating a CBLOHD bounce.
Let’s look at another common entry signal—a break. A break occurs
when price penetrates a level of support or resistance.
A resistance break occurs at resistance. This means demand has
overwhelmed supply and is a bullish sign—investors expect prices to
keep rising. This break is often accompanied by a surge in volume, which
many traders look for as confirmation. However, a surge in volume it isn’t
always necessary for the breakout to occur.
McDonald’s Corp. (MCD) struggled to break resistance at $103.75 for
nearly two years. In October of 2015 a good earnings announcement
caused the stock to rally on high volume. This is an example of a
resistance break.
A support break occurs at support. This means supply has overwhelmed
demand and is a bearish sign—investors expect prices to keep falling.
Volume may or may not accompany the breakout. This is because stocks
can “fall under their own weight.” In other words, sometimes the stock
simply falls because there’s not enough interest to buy.
American Airlines Group Inc. (AAL) experienced a support break in May
2015. In this example, volume did appear with the break, showing an
increase in supply.
Now, let’s talk about exits. Support and resistance can act as targets, or
prices set for an exit of a trade. A bullish trader could buy using a
CAHOLD support bounce and plan to exit at resistance, the resistance
level being the target.
Let’s put this all together with an example demonstrating how you could
trade support and resistance. Previously we observed Newmont Mining
Corp. (NEM) traded sideways between $22.25 and $27.25 for most of
2014 and 2015. In the example below, there were several points where a
trader could’ve bought on an upward bounce and sold at resistance.
Then they could've shorted on a downward bounce and then covered at
support.
When support broke in November, another short position could’ve been
taken. A technician would project new support by measuring the previous
channel and subtracting it from support. The height of the channel was
$5.00 ($27.25 – $22.25 = $5.00). This would put a target price at $17.25.
You can see on the chart new support occurred near $17.25.
We’ll go in further detail on entries and exits later, but you should have an
appreciation for the significance of support and resistance and how these
levels fit within the concept of trend. Remember, traders look at trend first
and assume that the trend will continue. Next, they look to support and
resistance as areas of supply and demand that can be actionable to open
positions or take profits.
