Support and resistance lines drawn on technical charts are widely used in predicting bounce points and reversals. Oftentimes, if you are monitoring a particular chart and its price movements, you will realize that there will be some resistance when the stock or index tried to fall below or rise above a support or resistance line respectively. While some might argue that these phenomena can be psychological in nature as the person who positions the line might be biased. However, if drawn accurately, it has also proven to be a useful way to plan for entries and exits at times. In this week’s post, we will be going through a few types of support lines used on actual stock or index charts to demonstrate their effectiveness and usefulness in reality.
Psychological Support levels
The above example shows a stock price bouncing from its psychological support and resistance price points at an interval of 10 cents. While none of these lines actually held the fort consistently, it did at some point provided an actual bounce point for investors to buy back or accumulate. Psychological support levels are usually only formed out of convenience for investors. This follows the logic of how retail pricing is set rounded up to the nearest decimal point or dollar. If you choose to use these support lines, expect to lose a few cents or pips in the process as such support lines do not hold when price volatility is high.
Generic support lines and uptrend support lines
Just wanted to show an example of an uptrend support line drawn which was proven to be ineffective in predicting bounce points over a long period of time. This shows that support lines alone will never be adequate in predicting entry and exit points. My suggestion for beginners is to zoom in to the charts and mark out multiple support lines to the best of your ability. Thereafter, set your entry price base on those lines and prepare your tranches of capital for trades. this is on top of preparing for contingencies when the stock price continues to go south. Check out Loopholes Singapore’s trading ideas page for some examples.
It is always exciting to think that you can mark out your own support and resistance lines and maximize profits in the process. In reality, it does not work nearly as elegantly as some might have imagined. These lines are drawn usually quickly expire and will not give you any warning when they do. At the end of the week, you will often be left with a tonne of lines drawn as shown above, and feel unsure which lines to take reference from.
Moving Averages as support and resistance lines
The colored lines on the chart above show the moving average with a different number of data points. Essentially moving averages are drawn using the mean value of the last X no. of data points defined by the user. In other words, if the user sets the coordinates to “1” then the moving average will be identical to the original price line itself. Using moving average as a support and resistance line relies on the understanding of mathematics as the larger the coordinates or number of data points, it means the moving will deviate further away from the actual chart. This means that if there is a huge price movement on any given day, it is probably not going to “bounce” from the moving average, thus serving as a support line. That said, if you notice the above example, moving averages are not going to be 100% accurate as well. Most experienced investors study each of their stock counters and will set the coordinates of several moving averages to determine not just support and resistance points but also potential trend reversals when the moving averages cross.
Closing Thoughts
While support and resistance lines are highly romanticized as the best way to determine entry and exit points, it is really not that accurate in reality. What about combining many types of moving averages? The short answer I will give is that it will only confuse you and cause you to doubt your decision further when things do not go as planned. My suggestion is for investors to understand each stock counter on their own so as to cultivate a price sensitivity for that particular counter. Over time, you will be able to use simple lines drawn to help you double-check your decisions on entries and exits.
