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In your analysis of potential securities to trade, you may consider the concepts of support and resistance. Support is a level in a security where the price will on more than two occasions move down to and bounce off, and literally find support at, as the name implies, as seen in the chart below.

Often these price levels where the support is found will be the same although this is not essential for support to be identified, as long as they are very close.




The concept of resistance is exactly the same as support except the direction that the security travels is reversed. Resistance is a level where the price will move up towards and fail to break through, and literally find resistance to moving higher.

The more times a security tests one of these price levels in the shortest period of time, the more significant that level becomes. When a security finds resistance there is little indication of which direction it will go. The buyers may give up trying to move the price higher and therefore the demand will dry up and the price may fall away from the resistance level.

Alternatively, the supply of shares may be eroded by the buying pressure and eventually the supply will dry up. This will result in the prices moving higher beyond the resistance level.

You will notice in the chart below that this security has traded to the resistance level and then moved away only to trade back and try again to break through. Finally, the supply of shares has been eroded away and the price has exploded past the resistance level.

This behaviour is quite common with prices moving past resistance levels especially the more significant the level is.


 

Coincidently, support and resistance levels more often than not occur at round dollar numbers or at multiples of 10 or 25 cents, further demonstrating the mass behaviour of people.

Support and resistance evolves from one thing – market participants. All the people in the market with buy and sell orders on the trading screen grouped together can potentially form support and resistance.

A security will not move beyond a level of resistance until all of the sell orders there have been removed by either enough buyers to take up all the shares on offer, or if some of those sellers decide to cancel their orders also of the opinion that the security may move higher.

Identifying support and resistance and reacting to different occurrences at those levels can assist you in your decision making and make you a more effective trader.

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