What are support and resistance lines? Why do support and resistance lines occur? Why are support and resistance lines important? How can support and resistance lines be used by investors?

What are support and resistance lines?

Support and resistance lines appear as thresholds to price patterns. They are the respective lines where prices stop going down or up.

A support line is the level that a stock's price generally does not fall below. It marks the price level at which there is a sufficient amount of demand to stop and possibly, for a time, turn a downtrend higher.²³ A resistance line is the level above which a stock's price generally will not rise. It indicates a price level at which a sufficient supply of stock is available to stop and possibly, for a time, head off an uptrend in prices. Trendlines are often referred to as support and resistance lines on an angle.

Why do support and resistance lines occur?

A stock's price is determined by supply and demand. Bulls are buying when they think a stock is priced too low. Bears are selling when they think prices have peaked. Bulls bid up the price by increasing demand, bears take it down by increasing supply. When the bulls and bears find a price point they can agree on, the market reaches a balance.
When prices are trending upward, there's a point at which the bulls begin to pull back and the bears become more aggressive - the market balances along the resistance line.

When prices are trending downwards, the market balances along the support line. As prices decline toward that support line, buyers become more inclined to buy and sellers starting holding on to their stocks. The support line marks the point where demand takes precedence over supply and prices will not fall below that support line. The reverse holds true for a resistance line.

Prices often break through support and resistance lines. A break through a resistance line shows that the bulls (the buyers) have won out over the bears (the sellers). The bulls are determined to bid the price of the stock higher than previous highs. Once the resistance line is broken, another will be created at a higher level. The reverse holds true for a support line.

Support levels can transform into resistance levels and vice versa. After prices break through a support level investors may try to limit their losses by selling the stock, pushing prices back up to the line which now becomes a resistance level.

Why are support and resistance lines important?

Technical analysts often say that the market has a memory. Support and resistance lines are a key component of that memory.

Investors "tend to remember previous area levels and thus make them important. While a stock is changing its price level rapidly, day after day, the public will be buying and selling at widely divergent levels and there will be no unanimity, or strong memory impression, in such changing prices."²⁴ But, when prices form an "area" and trade within a fairly narrow range for a period of time, investors begin to remember that specific price.

The longer the prices stay in that area and the greater the volume in that spot, the more important that level becomes because investors remember it exceptionally well. Therefore, that level takes on added significance for the technical analyst. According to experts, previous support and resistance levels can be used as "target" or "limit" prices when the market have traded away from them.²⁵ Assume that a year ago a rally ended with a top price of 125. That price of 125 then becomes a resistance level for the rally occurring in today's market.

How can support and resistance lines be used by investors?

Investors should be aware that support levels are usually below the current price; resistance levels are often above the current price. Also, it is not unusual for prices to move below or above a support or resistance level for very short periods of time during a volatile trading period.

Support and resistance levels are important tools for the technical analyst. By monitoring whether a stock's price is nearing a support or resistance level, an investor will be aware of whether a reversal may be in the offing. Together with monitoring the proximity of the price to the support or resistance level, a vigilant investor will also monitor trading volume in the stock. Increased volume is another key sign that a reversal may be at hand.

²³Edwards and Magee, p. 695
²⁴Schabacker, p. 305
²⁵Kahn, p. 24