Decoding Stock Support Levels: Trading Tips and Strategies
What Is the Support Level of a Stock, and How Do You Trade It?
What is Support?
Support, or a support level, refers to the price level that an asset does not fall below for a period of time. An asset's support level is created by buyers entering the market whenever the asset drops to a lower price. In technical analysis, simple support levels can be charted by drawing a line along the lowest low for the time period being considered. The support line may be flat or skewed up or down with the overall price trend. Other technical indicators and charting techniques can be used to identify more advanced versions of support.
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Key Takeaways
- A support level represents a price point that an asset struggles to break below over a given time period.
- Support levels can be visualized using various technical indicators or by drawing a line connecting the lowest lows for the period.
- Applying trendlines or moving averages provides a more dynamic view of support.
What do Support Levels Tell You?
In general finance terms, a support level is the level at which buyers buy or enter a stock. This stock refers to the share price that a company rarely goes down. When the stock price declines toward its support level, the support level remains and is confirmed, or the stock continues to decline and the previously displayed support level must be changed to include new lows. Support levels in stocks can be created by limit orders or by market action from traders and investors.
At The Core of Technical Analysis Are Support and Resistance Levels. Fundamental analysis takes into account a company's performance and history to determine the future direction of a stock, while Technical Analysis uses patterns and trends in price. Traders use support and resistance levels to plan entry and exit points for trades. If the price action on a chart crosses the support levels, it is viewed as an opportunity to buy or take a short position depending on what the trader sees from other indicators. If the violation occurs on an uptrend, it can also signal a reversal.
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Example of How to Use Support Levels
Let's say you're studying the price history of shares in a fictional Montreal Trucking Company with the ticker symbol MTC. You are trying to identify an ideal time to enter a long position in the company. Over the past year, MTC has traded between $7 and $15 per share. During the second month of the period you're studying the MTC, the stock climbs to $15, but falls to $7 by month 4. By month 7, it climbs again to $15 before falling to $10 in month 9. For 11 months it rises again to $15 and in the next 30 days it falls to $13 before climbing again to $15.
At this point, you have an established support level at $7 and a resistance at $15. If there are no other worrying factors on technicals or fundamentals, you can set a buy order at the lower end of the range. If you set an order at the support level of $7 there is a risk that an uptrend will set in and your order may never get executed despite the fact that you have correctly identified the upside. This is another reason why it is important to consult more subtle indicators in addition to simple support.
Difference Between Support Level and Resistance Level
If the support level is the price below which the stock does not move, then the resistance level is the price point above which the stock has trouble moving. Think of the support level as the floor and the resistance level as the ceiling.
Limitations on Using the Support
Support is more of a market concept than a true technical indicator. There are several popular indicators that incorporate these concepts, such as volume charts and price by moving averages, that are more actionable than simple visualizations. Typically traders will want to see support bands rather than a line connecting the lowest highs as there is always a chance that the support will move up and the order for a long position will not get executed.
Those interested in learning more about trading and other aspects of technical analysis can consider enrolling in one of the best technical analysis courses.