3. Support & Resistance - the high traffic areas on your "Road Map"
As we said before, prices ebb and flow across the charts like waves at the ocean. Why is that? Why don’t they move in a straight line from price to price? Well, if everyone had the same opinion about a stock or market’s price, it would pretty much move in a straight line.
That’s right. If everyone thought that Tractor Supply (TSCO), for example, was fairly valued at $90 a share, that’s where the price would stay, at least until some market event or announcement caused them to re-think their opinions. But in the real world, not everyone has the same opinion.
One investor may think Tractor Supply is a deal at $88 a share - another investor may believe that Tractor Supply is not worth $89 a share. As new information becomes available and share prices change, these 2 investors will likely change their opinions about buying or selling shares for their portfolios. With an average daily volume of close to 600,000 shares, you could say that investors change their opinions of Tractor Supply’s fair value 1.2 million times a day! That will put some ebb and flow on a chart, don’t you think?
This constant battle between buyers and sellers - so vividly seen on the charts - moves prices to and fro in an endless search for the right price, or fair value. As these levels of perceived fair value are reached, the trading activity shows up on our “roadmaps” as congested traffic.
Buyers and sellers are battling it out at these points on the charts to take control. Sometimes the market or stock will reverse at a resistance or support level, sometimes it will just “take a breather” and move sideways a while before continuing on its previous direction.
Take a look at how prices reacted around the support and resistance levels on this weekly chart for Cummins (CMI):
When viewing our charts, recognizing support and resistance levels can be very helpful in determining trend strength and market direction. For example, say IBM stock has been trending higher. It reaches a resistance point (ceiling) on its chart, pauses, then moves higher and right up through that resistance point - that’s a very bullish signal. That tells us the buyers are still in charge, there is still demand for this stock and it is likely headed higher.
On the other hand, suppose Apple stock has been trending lower. It reaches a support level (floor) on its chart, bounces higher, then drops right down through that support level - that’s a bearish signal. That tells us that the sellers are still in charge and prices are likely headed lower.
Learning to identify support and resistance levels will be the most challenging part of your chart reading education, but it will get easier the more you do it.
The point of recognizing them is to gain some insight on market direction. We don’t really care that the market or a stock is headed for a particular support or resistance level - we want to see how it reacts when it reaches that level. That reaction tells us a lot!