Professional traders and investors are always on the lookout for support and resistance areas that may affect their trades. In this article you will learn why this concept is so important to managing your trades.
If you are a bit familiar with the concept of support and resistance you will know how they work to affect stocks.
When a stock drops to support, it can either:
On the other hand, when a stock rallies to an area of resistance, they can either:
With these scenarios in hand, we know what to do in each situation.
If you are long a stock
If you are long a stock and your stock reaches to an area of resistance, you should be willing to sell some of your stocks. You should also try not to long the stock until you are certain that the stock can overcome the resistance
If a stock drops to a support area, you can think of buying the stock as the probability of it going higher is very good. Traders can buy it for a trade while an investor can accumulate the stock at a cheaper price at a good area.
If you are short a stock
If you are short a stock and your stock reaches an area of support, you should be willing to close out the position. You should also not short the stock until you are certain that the stock can overcome the support area and drop lower.
If a stock rises to a resistance area, you can also think of shorting the stock as the probability of it going lower is very good. Traders can short the stock for a trade.
Let us take an example of support area in the S&P 500. I have highlighted the support area in the S&P 500 with green color above. Notice how when the market drops to support area, it bounces up?
The first time it drop to that support area, it bounced up quite a lot. The second time the bounce up was a bit less but there is still a small bounce up.
If you are looking to find trades on the long side, then it is a good time to find long trades when the S&P 500 hits support. On the other hand, if you were short stocks, you should cover your positions as the S&P 500 hits support.
Let's take a look at how resistance works.
I have colored possible resistance areas with red color in the chart above. Previous highs can act as resistance. Therefore, if you are long a stock and the S&P 500 hits a resistance area, you should consider closing out the position or selling a portion of that position.
You should also not long stocks when S&P 500 hits resistance unless you are very certain that the S&P 500 can overcome the resistance. This usually happens with the S&P 500 forming a continuation pattern that slowly absorbs the supply from the resistance.
Some short term traders might want to consider shorting stocks when the S&P 500 hits resistance.
Now that you know what to do when the S&P 500 hits a support or resistance area, you need to come out with a trading strategy to enter stocks when the S&P 500 hits support or resistance.
That way you do not enter stocks blindly.
A good example will be this.
If the S&P 500 hits support area...look for:
The possibilities are endless. But what you need is a trading strategy. Without it, you will not be very successful in the markets.
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