If you only remember one thing after reading this post, support/resistance should be it. Whether or not you believe studying price history yields any value, it is undeniable that there are price areas where buyers/sellers tend to congregate.
The basic idea of support is that buying interest tends to wait for areas where significant historical lows have occurred, and historical highs for resistance. This article will focus on support levels, which are more useful to long-term investors.
If you like a stock fundamentally, identifying appropriate support to buy would be a wise bet vs. buying in the middle of nowhere. To illustrate this point, consider the following SIA stock chart.
We start by noticing that during the 2008 crisis (the worst stock market crash in recent history), SIA made lows around the $9-10 area. Looking ahead to the present, this zone has held up well, with each attempt to breach below it meeting with a bounce back above. If you were bullish fundamentally and waited for this price zone to buy, you would be in a much more advantageous position compared to someone who bought at $14, for example.
The same concept can also be used as an early warning system for a particular stock. Consider the case of Enron, one of the most notorious case studies for accounting fraud. What they do not teach you in business school, is that a simple understanding of support zones would have given you early warning signs.
Notice that the support levels of $60-70 was significantly broken by May 2001, but the first obvious signs of trouble only appeared in the second half of that year. Just by keeping a watch on how Enron’s price reacted around support zones, long-term investors could have started re-assessing the company’s fundamentals and consequently got out before it was too late.
Finally, the caveat. Investors must understand that no technical method is 100% foolproof. Also it takes some experience to identify appropriate support levels, and interpret price charts correctly across different scenarios. The goal here is to make more profitable investments more frequently, not hit home runs on every single one.
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