How do I identify support and resistance?

Support and resistance are representations of supply and demand, or rather the intersection at which supply and demand meet. These two forces drive the price of a financial instrument—supply drives price down while demand drives it up. Support can be defined then as the point at which demand is strong enough to halt downward pressure, and resistance is the point at which supply puts the brakes on an uptrend. No discussion of support and resistance is complete without mentioning trendlines. Trendlines are lines drawn under or over price pivot points plotted over time. As the name suggests, they give a visual depiction of the overall movement of a stock. They’re helpful in identifying price points a stock will have difficulty crossing. In the Tesla chart below, support is at $287 and resistance is at $297. The trading range stayed tight for the better part of the week before breaking out on the 30th. An interesting thing about support and resistance lines is that they become weaker the more price bumps up against them. When you see that, a breakout may be imminent. This is apparent in the chart below, where the price hugged the resistance line several times over the course of the week until the breakout on the 30th. Another thing to keep in mind about support and resistance: Once a breakout has occurred, the resistance line now becomes the new support line. On the other side of the coin, when the stock breaks through support, support becomes the new resistance line. Support and resistance are technical analysis fundamentals, but horizontal lines aren’t always the best way to identify them. Moving averages do a good job of smoothing out price data and highlighting support and resistance. In the Tesla chart above, the 15-day moving average is plotted in blue. Pay attention to the way the stock price finds support at the moving average on an uptrend and meets resistance at the moving average when it’s trending downward. Moving averages used in this way are helpful for predicting short-term price movements. The final thing to keep in mind when talking about support and resistance is the strength of the zones. If you think of a stock as a tennis ball, the support line as the floor, and the resistance line as the ceiling, the price chart replicates the movement of the tennis ball as it bounces against the ceiling and rebounds off the floor. This can continue for a period of time until an external force, in this case supply or demand, acts on the tennis ball. Imagine that at some point mid-bounce, the tennis ball turns into an iron wrecking ball. If it hits the ceiling (resistance), there’s a bullish breakthrough. If it falls to the floor (support), it will have a bearish breakthrough. The price chart gives some clues about when this might happen:  
  • The number of touches. A support or resistance level becomes more significant the more frequently the price bumps up against it. Experienced traders pay attention to those times and will make trades based on them.
  • Volume. When you see a lot of buying or selling at a certain level of support or resistance, the stronger that level is. Most traders trade on a successful support or resistance level and will return to them again and again to make trading decisions. This only reinforces those price points as support or resistance. In other words, when there is heavy volume and the price drops, you are going to see a great deal of selling the next time the stock hits that price.
  • Advances and declines. If you see a steep advance prior to the support and resistance zone, the resistance line is usually more significant than one that halts a slow, steady advance. The same works for a sharp decline.
  • Longevity. A support and resistance zone that has been tested over a period of months is more significant than a short-term one.