Starting out trading in the stock market can be difficult. There is so much information to learn and I bet you want to know it all as soon as possible. However, before you get caught up in the rush of indicators and variables of all kinds, you need to have a good understanding of this one very basic concept.
Resistances and Supports
Resistance levels are identified as a general price point that a stock tends to approach, but gets rejected at. This means that the stock usually fails to surpass this price level, and once it reaches this price level, it falls.
Support levels are the opposite. It is a general price point that a stock tends to approach, but then bounces off of. This means that the stock usually falls to this specific price, however, then bounces off of it and begins to rise once again.
Use the picture below for reference:
Resistance and support levels correlate well with supply and demand propositions. As demand increases for a product or service, the price will increase because of a decrease in the overall supply. If the overall supply increases, demand will likely decrease because there is not an abundance of that product, causing the price to decrease.
Did I lose you?
Use the image of a demand curve listed below as a reference:
For example, Stock CENT usually trades between $100 and $150. Whenever CENT approaches $150, many of the holders look to lock in their profits because they realize that this is a point where it usually “peaks” at. This rush of sellers causes a decrease in the demand of the stock, while increasing the supply available for sale. This causes the stock price to fall.
The stock price continues to fall as investors continue to sell. Once the stock approaches $100 once again, investors now realize that this is a “good deal” rangle for stock CENT because it tends to bounce at this price point and continue to rise. Now, investors are surging to buy stock CENT increasing the demand and decreasing the supply available for sale. This causes the price to increase, and the cycle continues.
Also, a general rule of thumb is that old supports become new resistances, and old resistances become new supports. Meaning that if a stock has pushed past a previous resistance level, when it approaches that same level again, it will likely experience a support.
These key price points can be great at knowing when to lock in profits and when to anticipate a change in direction.
It is important to understand that while patterns such as these tend to repeat themselves, they do not have to. Meaning that at any point the stock could break its pattern and push up past a resistance level or fall below a previous support level. You must use proper risk management skills that we will discuss later in the book to ensure that you are trading effectively while minimizing the level of risk that you are taking.
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