Support and resistance identify areas of supply and demand. But what exactly is supply and demand? Supply is an area on a chart where sellers are likely going to overwhelm buyers causing the stock to go down.
On a chart, we call this resistance. Demand is an area on a chart where buyers are likely going to overwhelm sellers causing the stock to go up. On a chart, we call this support.
Knowing this, it only makes sense to buy at support and sell at resistance!
Stocks run into resistance (supply) because those traders that bought too late and saw the price go down now want to get out at break even so they sell. Stocks find support (demand) because those traders that missed the move up now have a second chance to get in so they buy.
Ok, you probably already knew all that but here is something that most traders do not know. There are varying degrees of support and resistance.
On the long side: When a stock falls down to a prior low it is more significant than when a stock falls down to a prior high.
On the short side: When a stock rises up to a prior high it is more significant that when a stocks rises up to a prior low.
Here is an example:
The chart above shows how stocks run into resistance and find support. When this stock reached a prior high (resistance), it fell. When it reached a prior low (support), it rose. Now, look at the next chart…
This stock broke through resistance. When it pulled back, it found support at the prior high. This chart shows how resistance, once broken, can become support.