In this week’s FAQs we look at two essential tools for analysing charts: support & resistance, and trend lines.
What is support and resistance?
Support is a level where a share stops falling, or finds support as it falls. It will often bounce off this level more than once as buyers decide that the share is now cheap and add to their positions. Resistance is the opposite, where the share hits a price which stops its climb. It bounces back off the resistance and struggles to get above this level. These levels can often be formed by large buyers and sellers at a particular price or by investors and traders recognising the price as a critical level.
Once a share falls below support it can become resistance as the share struggles to break back above the price. In a similar way a break up through resistance can become support, holding the share price up. A break in support or resistance can lead to a strong price movement.
To identify support or resistance levels in a share use the trend line drawing tool in Market Analyser located at the left hand side of the chart. The trend line tool is also located in the top toolbar. Support or resistance lines are normally horizontal as they occur at the same price level. Try to join up as many turning points as you can with the line. A minimum of 2 are required. Sometimes the share may move slightly beyond the level and it may be necessary to ignore some of the shadows on the candles when drawing the lines.
In the chart above the resistance level becomes support once it’s broken and then a break below support was followed by a rapid fall in the share price.
How do I draw a trend line?
A trend line is similar to a support or resistance line, but instead of being horizontal the line slopes up or down. A trend line is drawn by connecting the troughs or peaks in the share price as it moves up and down. An up trend line is drawn underneath the share price to connect the higher lows and can be used to identify when the share price changes trend. A down trend line is drawn on top of the share to connect the lower highs and can be used to identify when the share stops falling.
When you are drawing trend lines aim to get as many turning points touching the line as possible. As with drawing support and resistance lines sometimes you may ignore the some of the shadows on the candles to get a line of best fit. If possible when you draw trend lines ignore the very highest point or very lowest point as these can be skewed by rapid movement. In Market Analyser use the trend line drawing tool located on the left side of the chart to draw the trend lines.
Once you have drawn a trend line you can draw a parallel line in Market Analyser to create a channel. Right click on the trend line and click on Duplicate Trendline. A new trend line will appear which you can drag wherever you want, by holding down your left mouse button when your cursor is on the line.
The upper boundary of the channel marks the top extreme of the price movement and can be used to identify potential turning points in the share.
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