It is very important to understand the concept of support and resistance.
In up trends, every time price drops to the up trend line and then resume their advance, the trend line has acted as support to the price up trend. Support can also be found at prices of previous support or resistance.
In down trends, every time price rises to the down trend line and then resume their decline, the down trend line has acted as resistance to the upward move of market prices.
Resistance can also be expected at prices of previous support or resistance. Once levels of support or resistance have been violated then invariably these reverse their roles, so that previous support becomes resistance and previous resistance becomes support.
Consider the following. When price action drops to a certain level the bulls (i.e., the buyers) take control and prevent prices from falling further. Similar to support, a "resistance" level is the point at which sellers take control of prices and prevent them from rising higher.
The price at which a trade takes place is the price at which a bull and bear agree to do business. It represents the consensus of their expectations. The bulls think prices will move higher and the bears think prices will move lower.
Support levels indicate the price where the majority of investors believe that prices will move higher, and resistance levels indicate the price at which a majority of investors feel prices will move lower.
When investor expectations change, they often do so abruptly. Note how when prices rose above the resistance level they did so decisively. Also similarly with support.
The development of support and resistance levels is probably the most noticeable and reoccurring event on price charts.
The penetration of support/resistance levels can be triggered by fundamental changes that are above or below investor expectations (e.g., changes in interest rates, government announcements, etc.) or by self-fulfilling prophecy (investors buy as they see prices rise). The cause is not as significant as the effect, new expectations lead to new price levels.
As you can see from the charts above. Some times the price will just keep going through support and resistance and sometimes it will come back to test its previous support or resistance line. This applies also to trend lines. We will be going into this in more detail in future chapters when we cover learning to trade.
It is essential to understand the concept of support and resistance. The validity of a trend line is dependent on its duration and the number of times it has been successfully tested.
The longer the trend line has been in effect and the more times it has been successfully tested the more important the trend line becomes. Consequently when a trend line of long duration, which has been successfully tested many times, has been violated then an important reversal of trend has likely occurred.
However, on no account exit the market until definitive evidence of trend termination has occurred. Remember another trading mantra -- The trend is the trend until proved otherwise -- to ignore this dictum is to unnecessarily deny yourself profits.
Author Resource:-
Martin Chandra is a full-time investor. He has been researching investment strategies and make his own living. For more information please go to here.
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