It was September 2008, and thestock market was in chaos.
The Dow Jones industrial average experienced its largest point
decline, plunging 777 points in just one session. Thesupport of
the 50- and 200-period moving averages were slashed like a hot
knife through butter, while the
VolatilityIndex (VIX )
rocketed through technicalresistance as if it wasn't even there.
The financial media was full of pundits declaring a complete
technical breakdown in the stock market.
Many were left asking what it all meant. Part of what it meant
was that the once esoteric quasi-science known astechnical
analysis had gone mainstream.
In the days before the personal computer, practitioners of
technical analysis usedquotes out of the newspapers orquote books
to draw charts and make projections.Intraday data were very
difficult to obtain outside of the exchange. Charts were
painstakingly plotted on graph paper with a ruler and pencil. New
highs and new lows were marked and repeating patterns noted in an
attempt to determine whether a price trend was likely to continue
Today, every trading platform has a charting package, often at
no additional cost. PCs permit the crunching of stock market data
in all timeframes, from thetick to the month and everything in
between. Rather than being an esotericinvesting tool, technical
analysis has become the norm. Many of the same concepts and ideas
apply today, just as they did back when investors would chart by
hand. One of the most used and important concepts of technical
analysis is the idea of support and resistance.
If you are a regular reader of my articles, you are familiar
with theterms support and resistance. However, I wouldn't be
surprised if a few readers did not fully understand what these
termsmean and how knowing about support and resistance can
dramatically increase your investing profits.
What Is Support And Resistance?
I define support and resistance as areas on a price chart that
appear to provide either support to falling prices or resistance
to the price moving higher. The measurement of support and
resistance depend on the timeframe involved. For example, support
on a daily chart would be different than support on a 15-minute
Support and resistance can either be horizontal lines on a
chart or consist of amoving average . A simple moving average
consists of the average of a certain number of periods, plotted
as one point on a graph.
For example, a 20-period simple moving average on a daily
chart adds together the past 20 days' movement, then divides by
20 to obtain the average movement. The end result is generally an
upward or downward sloping line on the chart that can act as
support or resistance. Often, when explaining technical analysis
topics, a picture can be better than a thousand words.
Here's an example of an upsloping simple moving average that
is acting as support.
Horizontal support or resistance is a little trickier to
identify on a price chart. My basic definition is any price level
that has been hit two or more times in the same direction that
has either supported price from moving lower or prevented price
from moving higher. However, a single-period high or
single-period low can also be considered support or resistance.
Remember, the more time price hits a certain level, the stronger
the support is thought to be. In addition, support or resistance,
once broken,will turn into the opposite.
Here are current examples of horizontal line support and
As you can see, on Safeway's daily chart, support exists in the
$22 range. Safeway investors would be wise to use thissupport
level as a stop-out point should price drop below it. In
addition, a technical buying opportunity will present itself
should the price hit the support level and then start to bounce
Micron Technologies (Nasdaq: MU)
This is a great example of both support and resistance. The lower
line in the $9 area is classic support and the upper line located
at $13 is classic technical resistance. Buying on a breakout
above the upper line or on a breakdown to the lower line, if it
holds, makes perfect technical investing sense.
Risks to Consider:
Technical analysis is an inexact discipline. It is ideal for
illustrating what has happened and for providing a context from
which to make investing decisions. It is most effectively used in
conjunction with other analytical techniques rather than by
itself. I like to think of technical analysis as a map used to
plan decisions, but with the caveat that outsidefactors that can
change the trip at any time
Action to Take -->
Review your portfolio from a technical perspective. Look at your
holdings on a daily chart while plotting support and resistance
levels and the 50- and 200-day simple moving averages. Does the
map match your expectations? You may be very surprised at what