A key ingredient to being a successful investor is knowing at all times where levels of support and resistance are.

Resistance is the area at which price progress has halted due to a decrease in buying and an increase in selling. It often occurs at levels where investors feel the stock is overpriced, but can also occur at previous highs as investors who bought at the previous high look to sell in order to break even.

Support is the area where buyers have begun to outnumber sellers, reversing the downward trend. Support areas indicate where investors have begun to feel the the stock is a good value.

It should be noted that resistance and support levels are not absolute as stocks will often break through resistance and plummet through support. I like to think of these areas as “tests” for the strength of a stock. Stocks that bounce off support and break through resistance are showing great strength and should be considered for purchase, while stocks that retreat at resistance and plummet through support are showing weakness and should probably be sold. Support and resistance become a self fulfilling prophecy as professional traders keep tabs on these important areas and make buy and sell decisions based on the action of the stock as it reaches support and resistance. You should be doing the same!
Common areas of support and resistance are presented below.

Moving Averages
Moving averages are important support and resistance areas to keep an eye on, specifically the 50 Day Moving Average. Many times, institutions and professional traders will add shares to their position at this point. However, a drop below this important line on heavy volume can signal further selling is ahead for the stock. Other important moving averages are the 20DMA, 35DMA and the 200DMA.

Trend Lines
Trend lines are also very important support and resistance areas and can be drawn in order to see where investors may buy or sell shares

To draw trend lines, connect support points to support points and resistance points to resistance points. A positive slope indicates and upward trend (higher highs and lows) while a negative slope would indicate a downward trend (lower highs and lows). Channel trends occur when there is no slope.

Whole Numbers (psychological support and resistance)
Support and resistance can occur at round numbers because traders tend to think in these terms when making buy and sell decisions. If a stock is purchased at 7 and makes its way past 8, then 9… they may say “if it gets to 10 I will sell”. With higher priced stocks multiples of 5 become more important. These become psychological resistance levels.

You see these psychological support and resistance levels mentioned in the news or magazines often. “Dow breaks 10,000!” or “NASDAQ needs to find support at 2000”

Gauging The Strength Of Support and Resistance
 Look at the history of the stock. Has it found support at a trend line or moving average in the past? How many times? If it has a history of showing support at a certain level, you can bet there is a good chance it will be supported there again. If it breaks the habit and is no longer supported there, look out! A deeper correction is most likely ahead.

Role Reversal
When a stock breaks support, that support line becomes resistance. Often times, a stock will break below major support and try and make its way back, only to be turned away by the new source of resistance. Why? Investors who purchased at support, only to have the stock plunge below quickly realize they made a mistake. If the stock makes its way back to the support area, they usually jump at the chance to get out without a loss. The opposite is also true. After a stock powers through resistance, that becomes a support area where traders are often willing to add shares. Investors who missed the initial move will often look to purchase if it makes its way back to the resistance area, creating support there.

Examples of Support & Resistance (click thumbnail for larger image)