[Shaw] One of the most
important aspects of technical analysis involves the judgment
of so-called support and resistance levels. Often one reads about
a stock that is selling, let us say, at 36, having support at
28-30, with potential overhead resistance at 43-45. Just what
is the writer talking about?
Let us assume that
you have been following the price movement of a certain stock
that has been trading for a period of time in a neutral fashion
- or fluctuating between the levels of 26 and 30. Obviously, during
the neutral price movement the forces of supply and demand have
been fairly equal. Ultimately the stock will break out of this
consolidation pattern in either an upward or downward direction.
If the direction is upward, thus indicating a surge of demand,
a distinctive clue would be given that the on-balance activity
that most likely occurred during the consolidation phase was accumulation
rather than distribution (see Assumption
2). Let us assume you made a commitment in the stock in the
26-30 zone prior to the upside breakout. Often an investment "story"
is not bought by all on the first go-round. Some extra convincing
is necessary. Such convincing can be accomplished by the mere
price performance of the stock itself. In the illustration above,
the stock has just moved up in price as profiled by the breakout
from the consolidation phase. Let us assume that some adverse
external news comes to the fore, and the stock experiences some
minor selling pressure, falling back to the area of the original
price consolidation. Chances are quite good that those who purchased
shares initially would not now be sellers of the stock.
In fact, they may even be inclined to buy more. And, of added
importance, investors who did not purchase the shares initially
may now seize upon this second opportunity to make a
commitment. The motivations just discussed are primarily predicated
upon (1) the recent price activity in the stock, during which
it was just selling at the higher price after breaking our of
the consolidation trend and (2) a feeling of confidence, to a
degree based on this price action, that the stock will eventually
resume its upward trend. It is mainly because of these psychological
factors that market analysis would anticipate that the stock in
question should find support between 26 and 30. At least initially,
there is a good chance of the stock bouncing back up. Thus, by
definition, a support level is a phase of price consolidation
- or congestion - below the current quotation of a stock.
Utilizing Assumption 3 for a minute,
the extent of the lateral consolidation often has a bearing on
the validity of the support. Minor consolidation suggests a minor
support level, where a more elongated congestion zone would suggest
It should now be simple
to explain resistance (or supply). Let us say your investment
made between 26-30 turns out to have been an error in judgment.
Instead of the stock moving up, it breaks down out of the congestion
pattern, reaching a level of 20. Mass psychology now begins to
work quite differently. Rather than taking the opportunity to
buy more shares at the current cheaper price, many investors will
simply bemoan their mistake and hope for a chance to break even.
This psychological behavior suggests that on any strength back
into the overhead consolidation area, the stock will meet supply,
or sellers will dominate. Whereas in the first example you did
not buy the stock to break even, in the latter case you are hoping
that a break-even position can be attained. Thus, by definition,
a resistance zone is an area of price activity above
a stock's current quotation. The influence of the resistance may
well depend upon the duration of the consolidation pattern.
Preference in Australian Stock Prices, Chris Doucouliagos, 2000
"Stock price rallies/declines often terminate at price levels
that are interpreted by many as areas of psychological resistance
or support, while an alternative interpretation is that they coincide
with price clusters. Some of these price levels tend to repeat with
a regularity that is inconsistent with mere chance. In this paper,
the existence of price clusters and psychological barriers is tested
on a sample of 20 Australian stocks. We consider two number sequences,
both derived from a base number of 100, as well as integer price
levels. It is shown that Australian stock price data are not uniformly
distributed and that for the majority of the stocks, price swing
highs and lows are associated with certain recurring price levels.
Some of the implications for trading and investing are considered".
Factors and Stock Option Exercise, HEATH, 1999
"Consistent with psychological models of values that include
reference points, employee exercise activity roughly doubles when
the stock price exceeds the maximum price attained during the previous
analysis in the Madrid stock exchange, Rodriguez, Rivero and
"In this paper we assess whether some simple forms of technical
analysis can predict stock price movements in the Madrid Stock Exchange.
Our results provide strong support for profitability of these technical