How to Trade Support and Resistance

One simple and straight forward approach to buying and selling stocks is looking at support and resistance levels. Being a fan of the K.I.S.S principle to trading, I like to apply these concepts for my swing trades.

“A support level is that price at which one may expect a considerable increase in demand for a stock, or buying. A resistance level is that price at which one may expect a considerable increase in the supply or selling.” – How Charts Can Help You in the Stock Market, Jiler
Scanning for stocks bouncing off support or breaking through resistance to new highs can offer two trading opportunities for making profits.

We always want to be in the best performing stocks in the market. To find these we can rank every stock’s performance over N number of days. Next, we look at the top stocks from this list to find buyable candidates. In Bluefin, we’ve filtered out the strongest stocks in the StockBee Trend Intensity, Sector 50, Earnings 50 and Post Earnings Surprise watch lists.

When looking at a trade, I will typically break it into two moves. First, we have the move from support to the resistance level. Then you have another trade where the stock breaks through the resistance to new highs. The move into new highs normally rewards the trader a higher percentage than between the two support levels.

Why do some stocks break through to new highs while others fail?

image

As our friend Laser put’s it, they do not have enough “Post Earnings Juice” to over whelm the sellers and push the stock to new highs. When this does occur, it can cause a feeding frenzy as the people who did sell, now panic to get back in.

Post Earnings Juice is all the good things you get out of earnings day. Stocks that blow out earnings, raise guidance, announce new sales agreements, receive upgrades have Post Earnings Juice. The perfect cocktail to drive stocks to new highs.

image

Following stocks with the highest relative strength will offer better opportunities for buying stocks bouncing off support. These stocks have proven themselves with strong uptrends prior to their pullback. The expectation is they will pullback after an initial 20% move or higher. After taking a breather they will continue their move upward.

image

Trades off support can be a bit more challenging versus a stock breaking through resistance into new highs. The best trade is trading the stock as it breaks through the previous high to new highs.

There is a higher chance the stock will continue moving sideways as it consolidates. Looking at OPEN (OpenTable Inc) you can see three different support areas with two having several weeks of consolidation while the middle only had two days.

I currently use the Harpoon scan to spot these moves. It scans all stocks up 1$ or greater. You can also use: c1 < avgc4.1 and c > avgc4. Basically, this scan looks for stocks making a short term trend reversal using the 4 ema. I was initially introduced to the 4 ema by Tumbler over at TumblerTrades.com when he was a Stock Bee Member. He uses this indicator for his day trading methods.

image

Let’s take a closer look at PANL. On 4/19, PANL ( universal display ) showed up on the Harpoon scan. It has a very strong prior uptrend and pulled back close to the 50 ma. It made a higher low compared to the day before and the market looked like it was turning at these levels.

My first target was the previous high made on 4/6/2011. At this level, the stock will either break out to new highs or fail. Taking profits on the third day and wait and see seems like a logical choice. The stock has to make 20% from pullback to resistance. If it was smaller percentage (8% or less) holding the stock would make sense.

IPGP is a good example of a tight consolidation where the stock had plenty of juice to make new highs. Buying the stock as it makes the new high is the best entry point for tighter consolidations like this. Otherwise, it’s possible the stock bounces back and forth between resistance and support for the next week.

image

When you enter a stock on the pullback you have three scenarios. A. The stock will go up making higher lows. B. The stock will continue consolidating and move sideways. C. The stock will make a lower low. I will sell on both option B and C and try again later.

image

There are some profitable opportunities trading support and resistance levels on high momentum stocks. Play deeper pullbacks up to 20% by trading bounces off support or wait for the break out to new highs on tighter pullbacks of 8% or less. Sell into strength and sell when the stock does not follow your plan.

4 Response to How to Trade Support and Resistance

Post a Comment