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Support and Resistance Levels

No one likes things that breakdown. When it happens to your car or the central air in your home on a 110 degree day in Phoenix you can get quite frustrated. After all you are depending on these things and when they break it is rather annoying. This happens to stocks as well.

A stock breaks down when price fails to maintain itself above a level of support. We all know by now that stocks typically trade within channels. There are levels of support and resistance and a stock will typically trend within those channel lines. We also know that a stock breaks out when it clears a level of resistance and moves into a higher trading range. That old resistance becomes new support. However the opposite is true when a stock breaks down; it drops down through old support to make new lows. The old level of support now becomes a new level of resistance. 

Whenever we mention that a stock would be better if it clears $X we're talking about levels of resistance. A chart may be starting to shape up and look decent but until it can clear resistance it will most likely stall out and not breakout. The resistance represents traders who held the stock at the previous levels. The typical trader will sell as soon as their old price is reached to get out of the trade even if the trade went bad on them initially much like we do here when we get stuck in a trade. They are just happy to get their money back and want out where they bought. As stocks approach levels of resistance the price swings can really get turbulent.

Knowing about resistance levels and the amount of volume it takes to clear out resistance is what helps us to know when to buy a stock before it runs. Using this same mentality we can then use this same information in reverse when deciding to take a short position in the stock. When a stock falls below support on volume then it is considered to be breaking down just like when a stock goes above resistance is called a breakout.  

I will typically wait until the move is confirmed with a price move to our buy point along with the volume to ensure it stays at the new price. This is why I will often mention that a buy point has been reached but I will not buy. If the volume is not there to confirm the purchase the breakout will likely fail. Same with break downs we are looking for volume to confirm the move down. 

We sometimes wait for stocks to comeback to resistance levels on light volume after a breakout on heavy volume has been confirmed. By doing this we do not get caught chasing stocks and we can take less risky long positions. Same with break downs you will notice that most of the short sell points are limit orders. This is because I am waiting for the stock to go back up to resistance on light volume after the heavy volume break down before shorting them. 

Just remember that shorting uses the same principals as taking long positions it is just in the opposite direction.

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