I’ve talked before about support and resistance levels being important concepts in charting or technical analysis.
In my previous article, I explained that support and resistance levels are signals which show psychological barriers in the movement of share prices. That article was written in late October 2008 — right when the GFC was hitting its straps! —and certainly the world has changed during those subsequent 18 months in terms of both psychological and financial results.
So what have we learnt about the sharemarket during that time regarding the significance of support and resistance levels? Can this charting technique still give us clues on where prices may be moving next?
Let’s recap by looking at how support levels work.
A support level acts like a floor to the share price. It’s a price point that the share price continually seems to bounce off and has a difficult time moving below. The more times that a share price bounces off this floor, the weaker it usually becomes.
Once the share price is able to break through the floor, it is considered significant because now the share price is free to move downwards until it reaches the next floor.
Often support and resistance switch roles. That is, old support levels become new resistance levels. We saw that happen quite a lot in the last 18 months.
Resistance levels act like a ceiling to the share price. It’s a line that the share price seems to have difficultly moving past.
Once the resistance level is broken, the share price is free to move upwards until it meets new resistance levels.
So just to recap, support and resistance levels can help us understand where share prices may be moving next. They are physiological levels in the share price.
Let’s take a look at the S&P ASX 200 as an example of these psychological barriers.
In this chart we can see that since September 2009 there has been strong support at 4500 points.
So if the market was to fall back now, it would probably not fall below this level. 4500 points acts like a floor to the sharemarket.
But if the market moves up, it’s likely that it may have a hard time getting past 5140 points. You can see that since July 2008, this resistance level has been held very firmly, so it’s likely that this psychological barrier of 5140 points will take a good hard knocking to break. Coincidently, this area was also support in 2006.
So you can see that during the past four years, support and resistance levels have simply been repeating the same old patterns — just at different levels.
As with the whole sharemarket, individual stocks also show support and resistance levels. And this is where I think we can take the learnings from the previous 18 months and use support and resistance levels along with another indicator to really take advantage in the sharemarket.
Here’s what I recommend: when you look at support and resistance, you should also take into account the volume of trades taking place to really help you place some winning trades.
An abnormally high level of trading volume for a share is like a siren that tells us that something is happening in that stock.
But if you’re trying to find an opportunity, it can be time-consuming trying to determine which stocks are having volume surges. So how do you find out which stocks to pay attention to?
This is where I have to say that I’m going to do a shameless plug about my employer Bell Direct, so forgive me! I’d recommend you use our Unusual Volume trading tool, which gives you a quick and easy view of spikes in volume for a trade. As they say, where there’s smoke, there’s fire, so the Bell Direct Unusual Volume tool outlines stocks with large increases in volume relative to their 50 day average volume for the same intraday time period. Pretty handy.
If you want to find out more about how this tool, take a look at my previous article about unusual volume.
Sure the Unusual Volume tool tells you that SOMETHING is happening, but it doesn’t show WHAT is going on. So it doesn’t answer all your questions. That’s when you need to dig a little deeper to find out more.
Digging deeper is pretty simple too. Just drill down into the company that interests you and read about the latest news or announcements.
Once you find out what is happening and determine whether it’s positive (and therefore likely to result in the share price rising) or negative (and likely to result in the share price falling) you can decide on how to act.
So remember, a high level of volume usually occurs at the start of a new direction in the share price.
Volume is one of the simplest and most undervalued indicators around. It can be a useful warning siren to let us know that something is happening to the stock price which then allows you to investigate further.
But like most indicators in general, volume alone does not give the whole picture. It doesn’t tell us which direction the share or indeed the market will go, and that’s why you can need to use more than just the volume to help you.
In summary, a break in support or resistance can be significant because it could mean that the share price is breaking free of a previous charted movement into new territory.
The key is to gauge whether the break is upwards or downwards to then try and profit from a strong move in share price.
Volume on the other hand is a further indicator that can be used to signal that something important is happening in the company.
Used together, support and resistance indicators alongside the Unusual Volume tool can really help you make a better call on your trades.
Happy trading!
Julia Lee Equities Analyst Bell Direct Have you started trading with Bell Direct for just $15 a trade? Register now for free.