Friday, August 19, 2011

Using Support & Resistance Areas

This post is to demonstrate how I use areas of support and resistance to analyze performance.

The term "area" is defined by a trading range across a period of time. Stock prices tend to have 3 phases:
1. Accumulation: the day to day or week to week rise in a price. This action return soaks up supply from the markets.

2. Consolidation: When a stock trades within a tighter defined range causing a compression in volatility.

3. Distrubution: The selling off of stocks and the day to day, week to week decline in price. This returns supply to the market.

The areas of support and resistance are when the same group of people and institutions trade with in a tighter lateral (sideways) range. Think of these areas as zones where either traders want to retain their capital. At support, traders tend to keep what they have. At resistance, traders tend to want to get their money back from losses.

SPY (the ETF that trades the SPX index) I use this chart because it shows buying and selling volume.

Click to enlage
• After the April/May 2010 peak and decline, there was 18 weeks of a choppy difficult to trade market ahead, with an eventual accumulation period breakout in September 2010. This break out had much less overhead resistance to work through to climb higher.

• We are in a much more severe correction period with a lot more supply on the market. The market will likely chop around in a bound range bound area between the underlying support area and overhead resistance before climbing higher (125-110)

• There is a lot more overhead resistance to work though. We need significant good ecomonic data in order to break through this resistance. This is not likely to occur for a while.

IBB (ETF that trades with Biotech stocks)

Note the price action demonstrating these areas of support and resistance.

Click to enlarge

• Underlying support from last year shows a higher volume of traders holding on to their positions not willing to sell off.

• 2 levels of overhead resistance will make it difficult for this ETF to climb higher. This stock could be range bound keeping it under $100 for a while.

I use these areas on a weekly timeframe to demonstrate longer term trends. These tend to be more useful than lines in this case.

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