Support & Resistance

Support and resistance lines are imaginary lines to indicate values at which values certain assets will bounce against and will face resistance in breaking through. If an asset value hovers above a line, we call that imaginary line a support, if the asset value hovers below a line, we call that a resistance. The idea behind the values of support & resistance lines is that an asset has tested those values before, and the asset has had difficulties in breaking that line before and bounces back. 

The chart above displays the evolution of the SP500 over the last years. We can see that there is an important resistance line at 2950. We can see that that line has been tested around October 2018, April 2019, June 2019 to shortly break through in August and October 2019. Each time the SP500 reached, or was close to reaching the 2950 mark, this probably triggered automated order executions and investors to sell their assets. We also see a resistance line at 3000 that got tested a couple of times around June-July 2019 and September 2019. Alternatively, we see an important support line at the 2600 mark. That one got tested around February and March 2018.

The general idea is that as soon as the asset drops through a support line it will drop in value up until the next (important) support line. The previous support line then converts into a resistance line. The SP500 drops through the 2600-mark, which originally was a support line. When increasing in value, the SP500 first bounces back a couple of times against the 2600-mark, which now temporarily is a resistance line, before it breaks through and starts increasing further in value. This happens in December 2019 and March 2020. 

Alternatively, when an asset substantially breaks through a resistance line, it will usually continue to do so up untill the next resistance line. This happens in January 2019, where the SP500 breaks through its 2600-mark, and increases rapidly up to the 2950, before bouncing back a couple of times against that value.

In general, the strength of a support- or resistance line is marked by a couple of elements:

- Support / Resistance lines always are horizontal

- The longer the history of the chart, the stronger the support/resistance

- The more the line got tested (bounced off), the stronger the support/resistance

- The further away a resistance/support line lies from the next support/resistance, the stronger the support/resistance

- Support/resistance lines usually have round numbers. In this case of the SP500, the lines were set at 2600, 2950 and 3000.

Modern Portfolio Theory
Technical Trading

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