The concepts of support and resistance are based on the price of a stock normally trading within certain limits (trading range). If the price of the stock begins to “test” the limits of the trading range, it could signal important changes that may occur in the near future.

So how do we establish the trading range to see the levels of support and resistance?
EMA’s (Exponential Moving Averages) are regularly used by investors and traders to indicate the areas of support and resistance. Also, trend lines can be drawn to indicate levels of support and resistance. As you become more familiar with technical analysis, you will become better at drawing trend lines. When the term support is used, it refers to the lowest price within the trading range. Resistance is the highest price within a trading range.

The 50 day EMA is a relatively reliable indicator, but the 200 day EMA is much more reliable indicator because it is a more significant average (200 days). Below is a candlestick chart of FRPT (Force Protection) that follows the basic concepts of support and resistance. Notice how the 50 day EMA acts as a resistance level in the beginning of November. The price “tests” the 50 day EMA, but “retreats” because of the “resistance”. It does not break through. On the 10th of November, the price “tests” the 50 day EMA again, but this time, it breaks through. There is a sell off and the price dips back to the low of November 9, which becomes a level of “support”. The next day the price “breaks” the 50 day EMA and this is the beginning of a new price trend (an upward rally). The upward rally reaches the next level of resistance (200 EMA), but breaks through it, confirming (and continuing) the current trend (upward rally).

From November to February, the 50 day EMA now becomes a level of support for the price. Notice how the price “rides up” the blue line (50 EMA). Also, the 50 day EMA looks like it is “holding up” or “supporting” the price. On January 20, the price “tests” the 50 day EMA, but is supported and does not fall below the 50 day EMA. Finally on February 22, the level of support on the 50 day EMA is retested, and breaks through. The 200 day EMA (a more significant moving average) can be used to “confirm” the change in price trend.

What did we learn?
After studying the ways that price is affected by support and resistance, you will have another tool in your technical trading arsenal to confirm reversals in price trends, and ultimately, help you make your trading decision.

Candlestick chart courtesy of: StockCharts.com

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