Support and resistance
We often use support, resistance or trend lines in our analysis and hopefully most traders and investors will understand the theory behind these lines. In technical analysis the chart is a powerful way of viewing a stocks price action, by drawing lines that touch on high or low points it is possible to see certain patterns emerging, these patterns can often be used to identify possible future price action. There is debate that these types of lines are self-fulfilling as buyers and sellers are aware of certain prices that are important to each other and therefore the trading becomes concentrated around these prices. Whatever the debate there can be no doubt that it is important to recognise these lines when trading.
We have covered this before in a lesson on Trend lines and trend channels. The more simple lines that can be drawn are 'support' and 'resistance' lines. The recent XJO chart below shows that there has been some definite congregation of price action at the level of 6180 - 6190 (shown in Orange)
By using the points where In May 2007 the XJO fell to this level we were able to draw in a 'support' line, this is a line where there were 2 distinct bounces off of this level and therefore the XJO appeared to be supported at this level. A bullish trader who was going long (or positive) on the XJO may decide to place their stop loss level just below this line in the belief that if the support level was breached then the XJO would continue to fall.
At the end of July the XJO fell from it's highs of 6436 and pierced the support line. It then appears that the support line has become a 'resistance' level in so far that since that date the XJO has been unable to climb above the line. This line can then be extneded to the present day. A bearish trader who shorted the XJO may decide that just above the line is a good level at which to place stop loss levels in the belief that if the line is pierced the XJO may once again find it a support level.