How to Analyze Support and Resistance Levels 

Correctly predicting stock price movements may help some traders outperform the market. Knowing which factors influence stock price movements makes it easier to forecast price changes and potentially gain an advantage over other traders.

Fundamental analysis and technical analysis give traders insight into a company’s strengths, weaknesses, and how it may trade in the future. While fundamental analysis looks at individual companies, technical analysis uses charts and historical patterns to help estimate price movements.

Traders use several technical indicators to analyze a stock’s short-term movement, including support and resistance levels. Understanding how these technical indicators work and using advanced technical resources may turn you into a more effective trader.

What Is Support?

Support is a price point that a stock seems to stay above. The stock may have fallen near this support price in the past, but for a sustained period when it gets close to the support level, the stock tends to recover in the short term.

What Is Resistance?

Resistance is a price point that a stock seems unable to surpass. When a stock’s price reaches the resistance line and fails to break past it, a downturn may follow. Resistance can ruin a rally, a short-term and often sharp upward move in prices, and result in a short-term decline if the stock is too close to its resistance line. 

The Psychology Behind Support and Resistance

Traders who use technical analysis carefully monitor support and resistance lines, looking for upheld trends and trend reversals. Changes and confirmations of trends can help traders enter positions with a higher probability of profit. As those trends become more clear, human psychology becomes a driving force that influences stock prices. How a stock’s price reacts as it approaches a support or resistance line can impact investor sentiment. Here are some of the ways human psychology comes into play as a stock’s price moves closer to one of the technical lines:

• A stock that stays above its support line may have room for upward movement in the short term. Traders may become bullish in the short term.
• A stock that stays below its resistance line may have more room to fall if it is near the line of resistance. Traders may become bearish in the short term.
• A stock that breaks its support line may experience more declines in the near future. Traders may become bearish in the short term.
• A stock that breaks its resistance line may experience more gains in the near future. Traders may become bullish in the short term.

Types of Support and Resistance Lines

Traders may look at separate support and resistance lines when deciding on their positions.  A technical analyst can look at short-term technical lines or long-term technical lines when crafting a stock-trading strategy. The support and resistance lines you choose impact the entry and exit prices since they will have different price points. Understanding the different types of support and resistance lines makes it easier to determine which indicators align with your strategy. 

These are some of the support and resistance lines to consider:

• Trendline Support and Resistance Levels
• Dynamic Support and Resistance Levels
• Round-Number Support and Resistance Levels
• Horizontal Support and Resistance Levels
• Fibonacci Support and Resistance Levels

Depending on which technical indicators you use, the support and resistance lines will have different prices, even if you are looking at the same stock.

1. Trendline Support and Resistance Levels

Trendline support and resistance lines consider multiple points on a stock chart. Trendlines respond to current market conditions, so a bearish stock market will lower the support and resistance lines. In a bull market, with a few days of positive returns, it can push support and resistance levels higher. 

2. Dynamic Support and Resistance Levels

Dynamic support and resistance levels use moving averages to determine support and resistance lines. Both lines move in real-time based on price movements. The 21-day and 50-day moving average lines are popular among traders and can reveal trends in the stock market.

3. Round-Number Support and Resistance Levels

Round-number support and resistance levels lean on human psychology. Most people set limit orders with whole numbers like $50 instead of including a few cents in their limit price (i.e., $50.38). Since most people set their orders with round numbers, a change to $49.99 or $50.01 can trigger many limit orders and prompt the next price movement.

Traders using this approach interpret round numbers as support and resistance lines. If a stock is priced at $42 per share, a round-number trader may see $40 as the support line and $45 as the resistance line. Some traders may get bullish if the stock exceeds $45/share or fails to fall below $40/share. However, the same trader may become bearish if the stock falls below $40/share or fails to rise above $45/share. While other trading strategies have entry and exit prices estimated by the cent, round-number support, and resistance lines are simpler since they deal with whole numbers.

4. Horizontal Support and Resistance Levels

Support lines can either be horizontal or diagonal. Horizontal lines stay in place, waiting for a stock’s price to break past them. This setup contrasts with diagonal lines, which move with day-to-day stock price changes. For horizontal support and resistance lines, traders identify two prices:

• A price the stock hasn’t risen above after multiple attempts (i.e., resistance)
• A price the stock hasn’t fallen below after a few close calls (i.e., support)

Traders embracing horizontal support and resistance lines tend to get bullish if the support line holds or the stock’s price breaks past the resistance line. The same traders may get bearish if the stock falls below support or doesn’t break the resistance line.

5. Fibonacci Support and Resistance Levels

Fibonacci Support and Resistance lines reveal price points that may indicate reversals. This technical indicator relies on the Fibonacci sequence to identify multiple support and resistance lines. Traders use Fibonacci tools to plot the horizontal lines used in this strategy. Fibonacci ratios are prevalent in human DNA, flowers, hurricanes, spiral galaxies and other parts of nature. Some traders believe they also apply to technical analysis. The Fibonacci approach allows traders to delve into long-term trends and review ratios to estimate when significant price changes could take place. 

The Fibonacci Support and Resistance Levels become relevant when the stock’s price approaches one of the Fibonacci lines. If the stock falls below the line or fails to break past resistance, traders view it as bearish. Traders may become bullish if the stock’s price breaks past a Fibonacci line or stays above a Fibonacci line instead of falling under it.

How to Plot Support and Resistance

Traders should identify price points on a chart that portray support and resistance. These price points help traders determine potential entry and exit prices and how to respond to stock price movements. While plotting support and resistance levels offers no guarantees, looking for sharp upward and downward price movements on a stock’s chart can help with creating lines of support and resistance. You need at least two price points for the support and resistance levels to plot lines.

Decision Making Based on Support and Resistance Levels

Traders can choose from several lines of support and resistance to estimate stock price movements. Memorizing these lines and reviewing  them on charts lets you see them in action, but how do traders turn this knowledge into stock-trading decisions? Here are two ideas to help illustrate. 

1. Trade the Bounce

The critical moment arrives when a stock challenges a line of support or resistance. If the stock does not break its line, it may continue to move away from it. To help illustrate this concept, a trader who follows this mentality may buy shares if a stock bounces away from its line of support. The same trader may sell shares of a company that does not break its resistance line or opts against purchasing shares. 

For example, if a stock has a support of $75 and a resistance of $80, an investor may buy shares if the stock hovers at $75.10 and shows a slight uptick. An investor may also opt to sell shares or avoid the stock if it is stuck at $79.90 and is experiencing slight downward pressure.

2. Trade the Break

Some stocks break past their lines of support and resistance, and many traders accept this as a short-term trend. In theory, a stock that breaks its support line continues decreasing, and a stock that breaks its resistance line continues increasing. No trader can predict how long these developments will remain intact, but trading the break can help traders potentially profit from either direction.

Using the previous hypothetical example, if that same stock falls below the $75 per share support line, a trader may become bearish. This trader may sell their shares or wait for the stock to continue falling before taking a bullish position. If the stock exceeds the $80 per share resistance line, a trader may become bullish and purchase more shares for a short-term rally.

Limitations of Support and Resistance 

Support and resistance lines can help traders make more informed decisions, but they come with risks similar to any technical or fundamental indicator. Support and resistance lines rely on past price movements and historical trends to speculate on the future price movements. This sometimes works out well for traders, but other times it does not and it is not a guarantee of success. 

Traders may also draw different conclusions depending on which support and resistance lines they use. The 50-day moving average may show a breakout, but the 21-day moving average may not draw the same conclusion. A trader has to decide at that moment which moving average they will use to determine whether a line of support or resistance has experienced a breakout.

Getting Technical with Investing

Support and resistance levels provide insights into a stock’s trends and past price movements. Traders can use these lines to search for patterns to estimate how a stock’s price could move in the near future. Technical investing is one element of a comprehensive investment strategy, and using a brokerage account with advanced technical tools can help you make decisions faster.

Frequently Asked Questions