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Technical Analysis Basics: Support and Resistance





Some believe that technical analysis is black magic and has no place in investing. Personally though, I think that technical analysis has some merit as it basically symbolizes market/investor emotion or sentiment. The  human nature reaction under particular circumstances tends to repeat itself, which is why technical analysis “can” work.

Learning about all the details of technical analysis is a huge task in itself with a very small percentage of traders that actually beat the market over the long run.  This article, however, will go over a very basics principle of technical analysis, support and resistance levels, which may help in your next trading decision.

Support

Support is an approximate stock price where there are buyers.  For example, if a stock pulls back in price, then bounces upwards again, it is said to have found support at that price.  As stock prices are typically volatile and can bounce around, support is confirmed if the stock price bounces off the same level twice or more times.

support

If there is confirmed support, but closes below that level in the future (with high volume), then support is considered broken and the price will generally go lower until it finds support again.  The old support level is now resistance.

Trend lines or moving averages on your stock charts they can also act as support or resistance.

Resistance

Resistance is the opposite of support where it’s a general price area where there are sellers.  If a stock is moving up in price and starts to turn around, it is said to have found resistance.  Resistance is confirmed when the same range is confirmed twice or more times.  Once a resistance level is breached though (with high volume), the stock price will generally go higher.  The breached resistance level is now considered support.

resistance

Support and resistance is only a small fraction of what technical analysis is all about and is only meant to peak your curiosity for future research.  This article is NOT meant to show you when to buy or sell stocks.

What do you guys think of the topic of technical analysis?  I could write more on technical analysis as I’ve been a fairly interested in this topic for a couple years now.  However, if you don’t find it interesting, then I’ll stick with the regular programming.





29 Comments, Comment or Ping

  1. I read about technical analysis in Rule #1 and it was a pretty good intro to stuff like stochastic lines, moving averages, and MACD lines. Like you said, it can tell you some stuff, but the risky thing is a lot of people see it and treat it like a math problem. Like they’ve “found” the solution to investing.

    Which it most definitely is not. Unless maybe you’re a day trader.

    This is probably the last thing wannabe investors should learn. Worthwhile? Sure. Essential? Not so much.

  2. Nice FT, I think its a great start. Support and Resistance are easy concepts and can make investors wealthy if they know what they are doing. Along with support and resistance though volume and momentum are other big factors.

  3. 3. Dajay

    Well, I would love see more information about technical analysis from you, but perhaps not on a daily basis.

  4. Fundamental analysis is great.. Technical Analysis is great as well. Without formulating a clear strategy for trade/investment execution however and STICKING to it an investor/trader would never make ANY money in the stock market.

  5. 5. abcstocks

    I am big fan of technical trading, I have developed my own set of rules and day trade using my rules as a guide. It is not 100% sure all the time but it gives me good headsup in advance for direction. Traders should use technical analysis as a tool along with fundamentals and sector strength to get the better result. Also, when technicals dont work then better to follow the market and rethink the stretegy time to time. For example, on my blog I posted on Feb 3, DJ index has EMA(72) is acting as a strong resistance.(http://canadianstockstrader.blogspot.com/2009/02/dj-chart.html). Currently index is testing the strong resistance so from a trading point of view it is very important to see if it breaks EMA(72) for stronger bull market.

  6. 6. Acorn

    FT,
    This topic is so huge… For so called “fundamental” investors this information is almost useless. For those who believe in it there are tons of educational web-sites available. Unless you are going to discuss it in-depth, don’t waste your time and effort for basic and simplified stuff. It might mislead people and make them believe that this is an “easy concept” and they can perform this analysis tomorrow (I’m sorry Blain Reinkensmeyer…). For me it took years and years…
    All my trades were based on the technical analysis and I’ve found that this approach is much more efficient comparing to the fundamental analysis. I’d like to encourage everyone to study technical analysis as deep as possible. Believe me and many other people – the charts (unlike of some CEOs, financial gurus on TV and etc.) usually don’t lie. They are trying to talk to you and tell you the truth. Don’t ignore a chance to learn their language…

  7. 7. Mark

    I think Writer’s Coin is hitting it on the head… On the other hand, once you get experience in regards to investing, It’s a topic you definitely need to be aware of…

    In essence though, I don’t believe most peoples reading your posts want such in depth info; I’d keep it on the back burner as far as regular postings go…

  8. 8. Michael

    After reading the all the comments I can see a case for both sides. It’s a tool to assist in investing and not the answer. I wouldn’t mind seeing some info on the moving averages and MACD. It makes for good reading.

  9. 9. Paula

    I agree that, in and of itself, Technical Analysis is interesting, but I’m not a true believer. It doesn’t explain why things happen and without knowing why you can’t make informed decisions.

    I’d be curious to see what the technical analysis said before the credit crisis, Dot-com implosion, or any of the other tanking stocks out there that took investors by surprise.

  10. 10. Ray

    Since i am a buy and hold investor Technical Analysis does not provide a great amount of value for me.
    I use technical analysis when I have decided to enter or exist a certain position.

  11. 11. Tommyboy

    Maybe I’m a little dense (or a lot?) – but let me see if I can paraphrase this: Support is the bottom, unless the price goes lower, then that becomes the bottom…how does that help?

    PS – I suffer from grammar-correcting-itis – it’s ‘pique your curiosity’, not ‘peak’

  12. Tommyboy – thanks for the correction, I’ve never used “pique” in a sentence before! With regards to support, traders use support in conjunction with other indicators to time their trades. For example, if a stock has momentum and is on it’s upward trend, it may be a good buy when the stock pulls back to support.

  13. 13. Tommyboy

    So another way to put it would be – historically, it proven to bounce back, so odds are it will – if you believe that stocks have memory. Is this analysis then more likely accurate for large cap vs. small, or does that not matter?

  14. 14. skube

    Thanks FT. I would be interested in learning more about technical analysis, different types of indicators and what they actually represent in the real world.

  15. 15. Acorn

    Paula,

    Some time ago we’ve had a “technical” discussion (see http://www.milliondollarjourney.com/how-i-lost-200k-without-losing-any-sleep.htm, post 14). I’ve predicted that NASDAQ Index will touch 1,200 – 1,300 level and it will be the bottom. At that time index was 1,800. Five (!) month later index touched 1,265 and it is the bottom so far. I didn’t have a crystal ball, just chart told me so. Believe me, everyone who can read the charts knew it… Everyone who can read the charts took profit before dot-com bubble was over. Only investors who refused to accept chart’s warnings were taken by “surprise” and lost the money. I can give you hundreds of examples… Citigroup… Technically, you had to dump this stock after Nov, 2007(!) and wait. Why people still buying? Based on what? They are just hoping…

  16. 16. Scott

    My one cent…(this one actually might be a ten-center):

    There is Fundamental analysis and Technical analysis.

    To do well in investing, you need both. Both are used because both work, independently, cooperatively, and sometimes not at all.

    The best example I can think of is the Nobel Prize winning Black-Scholes model (est. 1973). This “math problem” (based upon Japanese rocket science) was so good at predicting the future price of options that it was programmed into the computers that all the traders were using. And it worked like a charm. That is, right up until Oct. ’87. It had no idea what was going on and was spitting out garbage; it had become useless.

    Always remember, no system works forever! Use both because each will give you answers the other cannot.

    @ Paula: “It [technical analysis] doesn’t explain why things happen and without knowing why you can’t make informed decisions.”

    The Market doesn’t care WHY things happen, it only cares about Truth and Equilibrium. A chart is merely the EKG.

    As for people having to know WHY before they make “informed” decisions…that’s usually NOT how life works. Firstly, if you are driving along and a cop car pulls up behind you, lights and sirens blazing, what do you do? You probably pull over. Why? Because that’s what you have been “educated” to do. It doesn’t matter if YOU know the reason the cop is stopping you, you may in fact not have a clue, yet you still pull over. People do all kinds of things without knowing why; you would never give one faux copper penny if you need to be provided with certainty in Investment XYZ beforehand. Secondly, see my comments about Citi below. There are many uninformed people who make a lot of money merely going with the flow (ie the trend is your friend!).

    @ Paula: “I’d be curious to see what the technical analysis said before the credit crisis, Dot-com implosion, or any of the other tanking stocks out there that took investors by surprise.”

    It said the dot.com was unsustainable/unsupportable merely by the pitch of it’s ascent. Go look at the late-’90′s Nasdaq chart. Does THAT look like it has any type of support, anywhere? No. On the other hand, public sentiment (aka mania — remember the uninformed investor?) said the .com revolution would never end and there was a “new economy” here and now. Obviously fundamentals and technicals diverged on that one in a big way.

    Market returned to Truth and Equilibrium.

    On the other hand is the credit crisis. Techs told you nothing. Fundamentals would have told you something…if they weren’t fraudulent fundamentals. But most intelligent people knew something was far from right and dark days were ahead.

    Market is currently returning to Truth and Equilibrium.

    Get the point?

    Then there is utter absurdities that neither fundamentals nor techs support. Such is the case of Citi (NYSE: C). Fundamentally it is a bankrupt business; technically it collapsed 96% in less than one year. Would you invest in that company? I wouldn’t. Then a few months after going bankrupt, the fundamentals state it is now a profitable company; the techs record a price eruption. Neither fundamentals nor technicals are at Truth or Equilibrium in this case.

    [I know a person who DID buy the Citi lie at $1, knowing full well he was buying the lie, and sold the lie at $3. He made a good whack o' cash (+200% profit) in a couple of days. Good for him. I, however, don't like to support fraudulence, at any level, even if it would have made me richer. Call me stupid, call me naive, call me Ishmael...]

    Never forget, technically, ALL investing is based upon fundamental human nature. Make of that what you will.

  17. 17. Dana

    Good post, nice to see more serious discussion on technical analysis. To me, technicians provide a lot of assurance on whether fundamental analysis has merits. There have been instances when technical analysts have sold stocks based on charts long before other analysts sniffed foul accounting.

  18. 18. MM

    I’m actually surprised to see the number of interested people commenting in favour of Technical Analysis. I would expect the PF bandwagon to blast it to pieces and shout Index! Index! Index!

    Despite his dubious stock picks, Cramer’s saying “buy and homework, not buy and hold” is good advice whether it be from the technical or fundamental perspective.

  19. 19. Mechanonuke

    ‘Technical Analysis’, ‘Chart Reading’, etc. are all black magic voodoo concepts/strategies. I agree with the statement that ‘they work, until they dont work anymore.’ Exactly like going to the casino and sitting in front of a slot machine until its warmed up enought to pay out.

    These strategies do not offer *any* protection of your initial invested capital. You may end up making some money short term, or day-trading, but longer term all you need is one unexpected market correction, and poof, you’ve lost those potential gains and original capital.

    Statistically some will make money using technical analysis more often than not. But its my oppinion that if it was possible to average the returns of all technical analysis followers they would be at a 0-gain (or more likely negative, especially taking into account commissions).

    To all potential technical analysis investors…aka expert fininancial historians. Beware.

  20. I think having Technical Analysis would be interesting – but not on a daily basis. Maybe weekly?

  21. 21. Sampson

    Mechanonuke,

    Although I’m not a huge supporter of technical analysis I have to disagree that the downside is that:

    “These strategies do not offer *any* protection of your initial invested capital”.

    Are you suggesting that only PPNs, GICs, and CDs are the only good longer term strategies? because from what I understand, they’re the only investments that actually have no principal risk (aside from inflation). Selecting equities based on fundamentals analysis also offer zero ‘protection’ to the initial invested capital.

    Also,

    “Statistically some will make money using technical analysis more often than not” – doesn’t this actually mean it IS a winning strategy?

    I do absolutely agree with your warning – just like any other strategy, you do need a good level of understanding before venturing into voodoo.

  22. 22. Scott

    Would your definition of technical “voodoo” differ from the fundamental “voodoo” multiple international corporations engaged in during the last X number of years? All those tricky, fraudulent bookkeeping strategies and exotic swap concepts sure worked like a dream…that is until they didn’t work any longer. Then look what happened.

    There is no possible way to know a company 100%, inside and out. The best you can do is use every tool available to you to try and ascertain if said company is a good buy/sell for you.

    What I don’t understand is why people would reject technical analysis simply because it is technical analysis. It must have some merit and value in the realm of making money or it wouldn’t be used at all.

    I believe, and I may be mistaken, but didn’t Jesse Livermore start his great investment career (at age 15) by taking note of patterns in price movement — a technical analysis device? I’m sure if TA was good enough for ol’ Jesse to use, it’s good enough for all of us non-multi-millionaire types.

    But, whatever, each to their own.

  23. 23. Mechanonuke

    Sampson, Scott,
    Please read Security Analysis by Graham/Dodd. Opened my eyes RE: the fallacies of a number of strategies, including technical analysis.

    Technical analysis has but one true merit. It is wonderful record of PAST history, nothing more.

  24. 24. Cdnpatriot

    Name one Technical Analyst that has made significant money. Both Buffett and Soros are invest on fundamentals. The fact that there aren’t any questions the use of technical analysis

  25. 25. Scott

    You guys are funny.

  26. 26. Tom

    It would be interesting to see people that have made money CONSISTENTLY using this method. It seems almost like luck.

  27. 27. Scott

    YOU stand at half-court and hurl a basketball toward the net, it goes in. That is luck, a one-shot deal. You win a car.

    M. Jordan stands at half-court and hurls a basketball toward the net, it goes in. That is skill, practice, knowledge, wisdom, self-assurance, professionalism, to name a few winning adjectives, duplicated with accuracy and dependability over time. MJ wins a small fortune.

    It can be done.

    One percent (1%) of the world’s population are millionares, or roughly 67 million rich dudes and dudettes out there whooping it up (albeit probably a bit less these days). I would bet that even 1/2% of that 1% has, and currently does, takes profits CONSISTENTLY with the aid of some form of technical analysis.

    People seem to forget that technical analysis is everywhere, and, sorry to say, lays hand-in-hand with fundamentals. TA is merely a visual representation of the underlying numbers. Ever use a pie chart? Or sine wave? Fractal? Video game? No? Lucky fundamentalists.

    The world of business is fundamentally about selling stuff and making money; technically it’s all about the numbers = it’s BOTH!

    For the record, I personally knew a man who operated his own investment company. He and his partner had a few hundred clients. He was very successful. The MAJORITY of his work was based upon technical analysis, leaning heavily on the simple ‘R-squared’.

    Numbers doesn’t lie, people (CEO’s) do. Unfortunately, it’s people who produce and manipulate the numbers. So, yeah, it’s tricky. There is no silver bullet. Basically, use whatever works for you, use what makes you successful. But don’t discount something merely because of your beliefs.

  28. 28. kranny

    If you think TA is a mathematical formula for success in the market you don’t understand TA or investing. Its a tool kids…. a tool and used properly can ASSIST you in making decisions. Plenty of technical warning signs to get out of Enron before it imploded, but yet it was a BUY until the dying days… weird hey? Take it for what it is… and for the love of all that is good and evil quit using that stupid buzz word crap … voodoo and black magic.

  29. 29. sunshine

    I’m still a newbie on my path to becoming a sophisticated investor, but from what I’ve read on your blog so far, it seems to be a well-rounded eclectic approach to investing so I would like to see more inclusions on technical analysis and other strategies, as this is a major tool. Whether it’s useful or not is up to the reader themselves to determine.. and I don’t know about others but it would be helpful when I get some meaning out of the charts!

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