Trendlines, Support and Resistance

First we're going to talk about trend lines and in my mind trend lines are the one most important thing you need to know to trade stock charts now trend lines may sound like a simple concept and they are. But even though their basic trend lines and the ideas of support and resistance which we'll talk about are really the foundation for almost all technical analysis there's an old saying in trading that the trend is your friend and that's something I really believe in and it's a simple concept. But as you know I'm all about simplicity. So as we go through my stacking system and looking for the three C's we always want to start off with some sort of catalyst. Did the stock price do something different was there a change in how the stock price was acting. That causes us to even look at a trade and oftentimes that change that catalyst is the stock price breaking some sort of trend or going above or below a level that you wouldn't expect it to so if we pulled up a stock chart like this and gave it to a 10 year old and ask them what is the trend what would he say. Well he'd probably look at and say well the trend is up and if we more specifically said OK let's just take this area where it was trending up and ask them to draw a trend line draw some sort of line that that shows that trend. He might draw something like this kind of showing the tops of of how that stock was trending. He might draw it on the bottoms of where the lows were. And you know kind of like as it was trending up sometimes up had people even just dropped right in the middle and say well the trend is up and this is kind of like the average of how it was trending and they'd all be right. You know they're all conceptually focusing on the uptrend. But what we really want to do for our purposes is focus on trend lines as either support or resistance. That's where we want to draw our trend lines and use them as as catalysts for for how we're going to trade. So what does that mean. So support is a level that a stock price doesn't break below. So let's pull up the stock chart like this and just look at this area right here and see if we can identify some sort of support level some sort of floor that the stock price would hit. It might look something like this right. You can see almost visually that every time the stock price would hit this level the stock would bounce up. It was like a clear floor for that stock price. And if you were to draw a trend line it might look something like this. If we drew this horizontal line we would call it horizontal support. And every time it hit this level we would expect it to hold. We would expect it to be a floor and resistance is kind of the opposite. Right it's a ceiling it's a level that the stock price doesn't break above we can actually pull up the exact same chart we had before. And again just focusing on this area right here can we visually see a level. There was a ceiling a level that the stock price wouldn't break above clearly would look something like this right around this level it was a brick wall. And every time it would reach this level the stock price would sell off. And so we could draw a horizontal resistance line representing the ceiling representing this resistance where every time it would hit we would almost expect it to sell off so what creates the support and resistance line. Why why do stocks hold these levels. Well when a stock price swings what's really happening. Remember a stock's price is really a battle between buyers and sellers. So support levels levels where stocks bounce off of our lows where basically buyers overtook sellers. In other words the stock hit a value that more investors found attractive and piled in to buy. Why did that happen. Well sometimes a stock will just hit some sort of fundamental valuation level that more investors just find attractive. Sometimes there's good news sometimes the market's strong or sometimes just one side exhausts itself. Right. You just run out of sellers and buyer interest overtakes it. But whatever the reason the conclusion is the same. The stock hit a level where there were more buyers and sellers and that's important. Obviously another thing to keep in mind with support levels is these are also levels where buyers who stepped in will start losing money if it trades below. And that's why we'll see later on why support levels are so important. But again remember important battlegrounds create support and resistance. So when we think about support and resistance a lot of times we'll look for previous highs and lows and other major turning points and also areas of just congestion and consolidation where there are a lot of back and forth movement. These are all important levels to watch for when we're thinking about support and resistance and because support and resistance represent these important levels breaking them are a big deal. And that's why I'll use tests of support or resistance or breaks of support and resistance as a key catalyst as a key trigger for many of my trades.