Support and resistance levels are prices at which stocks or futures lose momentum due to previous buying or selling pressure. These levels can be spotted on weekly, daily, and intraday charts. Support and resistance levels are important in determining the risk-reward ratio of a trade.
Support and resistance levels can be used in two basic ways: Buy at support and sell at resistance; or buy when resistance has been broken and sell when support has been breached. If prices break through resistance, the old resistance becomes new price support. If prices break through support, the old support becomes new resistance.
It is important to know the price levels for support and resistance for the broader market, the sector in which you have positions, and the individual stock you are trading. For example, if you are trading Yahoo (YHOO), it is important to know where the sup port and resistance levels are for the NDX, the Internet index (DOT), and the individual stock.
Significant support and resistance levels cause prices to reverse. They mark the end of a trend and are usually accompanied by above-average volume. The volume in many cases can be climactic, marking a grand finale of a battle waged between the bulls and the bears at that price. These battles provide important signals to the shrewd trader who knows how to spot them. You will be able to increase your trading effectiveness should those levels hold or be violated.
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