Support and Resistance

It's not in the way that you hold me
It's not in the way you say you care
--Toto

A while back we introduced technical analysis by studying the basic patterns of uptrends and downtrends. Two more basic technical patterns are known as support and resistance.

Support occurs when a horizontal line can be drawn to connect several low points in a series of prices. Support reflects latent demand at a particular price level. Every time price drops to a particular level, buyers show up to 'support' the security at that price and keep it from moving lower yet.

Technicians often view support levels as attractive entry points because they often coincide with near term lows in the stock price.

Be aware, however, that a general rule of technical analysis is that each time prices come down to support levels, latent demand gradually gets stripped away and those support levels weaken. Buyers slowly get their fill and at some point the support level gives way.

Recent price action in Cisco Systems (CSCO) offers a good example. You can see that the stock bounced off support at about $51 several times over the past few months. With each touch, however, latent demand weakened as buyers at that level gradually acquired all they wanted. A few days ago, the stock broke thru support when no latent demand remained.

Now that Cisco's stock price has moved substantially lower, that $51 level has now become a technical level of resistance. Resistance occurs when when a horizontal line can be drawn to connect several points high points in a series of prices. Resistance reflects latent supply.

In CSCO's case, think of it this way. Many of those buyers that materialized to purchase the stock at $51/share are now underwater on their positions. Consequently, some of them wouldn't mind selling if/when the stock gets back up to $51 so that they break even on their trades. Thus, every time the stock gets back up to the $51 area, we can expect at least some hesitation in further gains as some of those previous buyers become sellers.

Technicians sometimes view resistance levels as good places to sell positions because chance favors a pullback in prices. However, just as continued touches of support strip away latent demand, continued touches of resistance strip away latent supply. As sellers 'get done,' there is less supply to restrain further price increases.

A multi-year chart of monthly gold price demonstrates. You can see that gold prices were repelled several times over the past few years by resistance in the $1350-1375 price range. A couple months back, prices broke thru resistance as demand finally outstripped remaining supply at that level. Now, previous resistance has morphed into a level of technical support.

And so it goes...

Being able to identify support and resistance levels adds context for better investment decisions.

positions in CSCO, gold