The markets are closed today in observance of the Fourth of July Holiday.
However, that doesn’t mean that we can’t use part of this day to develop some of our skills and trading knowledge.
For example, one of the most difficult concepts to learn is structuring a trade (I get more in depth in this video series).
Obviously, it only takes a click of a button to buy or sell a stock, that part isn’t difficult.
But for most novice traders, answering these questions are.
- At what price should I enter my stock order?
- How much room should I give it?
- What’s a realistic price target?
- Is there a level in which I should be taking a loss?
- Is there a level where I should double down if I’m wrong?
And you know what?
For the first couple of years of my trading journey, I struggled to find those answers too.
That said, I’ve devised a lesson on “support and resistance” and how I use them to answer the above questions.
If you’ve ever looked at a chart before, you’ve probably noticed that there are levels where the stock bounces off of… and levels where the stock just reverses from.
Well, those are called support and resistance lines.
Now, I actually use these lines for my trading in order to time my entries and exits to near perfection.
If you actually know what you’re looking for, trading becomes a lot simpler.
There are some different ways to look at support and resistance. The most basic way is to look at the levels historically.
For example, when you’re looking for support, try to find an area where the stock or exchange-traded fund (ETF) had a tough time breaking below. This lets us know it could be a good area to buy a stock.
On the other hand, when you’re looking for resistance… look for a level where the stock or ETF had a tough time breaking above. This is usually a good area to take profits.
Here’s a look at the daily chart on Facebook (FB).
Notice the lower line right around $160 is a key support level. In other words, there were buyers at that level… and FB was having a tough time breaking below that.
Now, if you notice the upper blue horizontal line, that’s a major resistance level. Typically, when a stock approaches a recent high… that’s a major resistance level and some traders like to take profits before the stock gets near that level.
Remember, since we’re dealing with charts here, it’s an art form and not a science… and it takes a bit of practice.
For example, if you look at the chart in FB above, there are some other support and resistance levels in between the ones I drew above.
Here’s another support / resistance level
If you look again, you’ll notice a purple line right at the $175 level. Now, initially, you can see FB had a tough time breaking above this. It kept trading in between ~$160 and $175.
However, once it broke above that, you can see $175 has become a support level – in other words, it’s another level to keep an eye on if you’re long the stock or trying to pick up shares.
Now, there’s also another way to spot support and resistance, and that’s by using moving averages.
Moving Averages As Support and Resistance
Basically, simple moving averages (SMA) are trend-following indicators. The main SMAs that traders look at for support and resistance are the 20-, 50-, and 200-day SMAs.
It works the same way as the horizontal resistance lines, except moving averages are more dynamic. You see, as the price changes… the moving averages take that into account.
For example, here’s a look at the daily chart on FB again, this time with the 20-, 50-, and 200-day SMAs.
For example, if you look at the green line, that’s the 50-day SMA. Well, FB has had a tough time breaking below that. In other words, it’s a support level… and that’s typically a good area to buy.
Let’s assume you think that 50-day SMA is going to hold as support, and you pick up some shares around the green encircled area.
Well, you set your first target at the first blue horizontal line (a resistance level), then the upper blue horizontal line as your second target… and the third target at $200. Additionally, let’s assume you would stop out if FB breaks below the 50-day SMA.
Well, if you look at the chart over time, the 50-day SMA was actually moving higher, and even if your stop was the break below the 50-day SMA… you still would’ve had some profits. You can see that FB broke below the green line in the red encircled area. If that happened, you would’ve just sold your shares.
Now, you should understand the basics of support and resistance… try to find other key support and resistance areas in some stocks you like… and you should be on your way. But first, let’s test your knowledge.
Check out this chart in Apple Inc. (AAPL)
Which of these areas would NOT be considered support?
- The blue horizontal line.
- The orange horizontal line.
- The red line inside the green rectangular area.
- The purple line.
Now, here’s a look at AAPL again, which of these would be considered a resistance level?
- The blue horizontal line.
- The pink horizontal line.
- The green horizontal line.
- All of the above.
Comment with your answer below.
Now, if you want to learn more about using charts to find trades, then click here to learn how I’m able to use 3 simple trend lines to consistently pull profits from the market.