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Chart Point
Chart Pattern
Elliott Waves
Support and Resistance

Chart points are probably the most important part of technical analysis. Sometimes, it tells you where the medium to long-term direction is if a major support or resistance point is broken. Traders open long position right above the support level and open short position right beneath the resistance level. Stop loss sell orders are executed once the support level is broken or stop loss buy orders are executed if the resistance level is broken.

Many program trading are based on this logic. We're going to briefly explain what make a price level to become a support level and what make it to become a resistance level.

If you get the chance to see the share price of company ABC trading at $35.00 while it's trading around $50.00. You'd like to buy it when it hits $35.00 again given that the fundamental of company ABC hasn't changed since the appreciation from $35.00 to $50.00. Similarly, you might have bought some shares right before the market was crash. You probably like to get rid of the stock when the share price bounce back to that level given that the fundamental hasn't improved yet.

Also, breaking of resistance level will turn the resistance line into support line as stop loss buying usually push the price a lot higher. The same logic applies to support level.

Learning stop loss is probably the first lesson of any trader. Chart point is the most useful reference of where to stop.

Retracement or rebound target
Support and resistance can be calculated from a famous Fibonacci ratio called Golden ratio. The sequence is introduced by an Italian mathematician Leonardo Pisano Fibonacci. The golden ratio of the sequence, 0.382, 0.618, 1.618, 2.618, etc have been found with a high correlation in the nature. Those are very interesting findings. Human is part of the nature and our behavior and reaction to stock market have also shown the connection to those ratios in the market prices.

The peak of NASDAQ was about 5048 as of 6 March 2000. It dropped to 5200 as of 22 May 2000. Afterwards, it rebounds back to about 4300 level. Try to work out all these retracement or rebound targets by yourself using our Fibonacci calculator after this lesson. You might want to do some homework as well. You may be very amazed by the accuracy of the golden ratio in the financial market. USD/DEM exchange rate had so many classical examples. It's worth doing some exercises. Remember to choose a security that has a high volume of transaction or high liquidity.

How to calculate?
The price of a security moves from A to B. The retracement or rebound targets most likely falls into one of the four percentages. 38.2%, 50%, 61.8% or 100%. 38.2% and 61.8% are the golden ratios. If you believe the trend will continue, you should buy on any of those retracements or sell on any of those rebounds. The calculation is as follows:

  • (A-B) x (1- 0.618)=38.2% retracement or rebound.
  • (A-B) x (1- 0.5)=50% retracement or rebound.
  • (A-B) x (1- 0.382)=61.8% retracement or rebound.

Support and Resistance at projection targets
Projection is the immediate target after the retracement of rebound. Price goes from A to B and retrace to C before it gets to D where it's the resistance or support. D can be measured by the length of AB.

  • D=C-1 x (A-B) for downtrend. It can extend to 1.618 or 2.618 of (A-B).
  • D=1x(B-A)+C for up trend.

Trend lines support and resistance
Lastly, support and resistance can be found on a trend line. Price usually moves in one direction until some negative factors from the market that have a more dominant effect. If people are not so sure where to go, the price may be trading in a range before it heads higher or lower. Being able to identify whether the price is in a trading range or in a trend is important. Fundamental judgment is required.

This lesson has taken you through different ways of calculating supports and resistances. It's very helpful to open a position, to close a transaction and to stop loss. You may find a support or resistance level that is a combination of both trend line, Fibonacci ratio as well as previous peak or bottom. It's usually very reliable.