When you’re first starting to trade stocks, there are a few basics you need to understand. Now, many traders employ technical analysis to time their trades for entry, exit, stop-loss and target prices. You should have a good understanding of the foundations of technical analysis. The first thing you should have a good grasp of is support and resistance. I use this all the time to spot potential trades and develop a plan from this tool. That in mind, let’s take a look at how to use support and resistance to trade stocks.
How to Use Support and Resistance to Trade Stocks
Technical analysis is an art form, not a science. You should always keep this in mind. When you’re looking at support and resistance, you should think of it as an area, rather than using the exact price. Remember, not everyone “respects” the support and resistance, and therefore, the price may break below resistance and then fail.
Moving on, let’s define support and resistance so you have a better idea to use these tools to trade stocks.
Support and Resistance Defined
Support is a price area where the stock has tended to hold. In other words, the support area acts as a floor and buyers are willing to step in and purchase the stock there. On the other hand, resistance is a price area at which the stock has tried to break above, but fails. Basically, it’s an area where sellers are willing to sell their shares or short sell the stock.
It’s pretty simple.
Here’s a look at how to use support and resistance to trade stocks.
Now, Twitter (TWTR) has support around $42.50 – $43. This is an area where market participants were willing to buy the stock, driving the price higher. On the other hand, the resistance is around $47 – $47.85. This is an area where the stock has failed to break above. Since TWTR hasn’t broken below or above the support and resistance, respectively, we say the stock is trading in range.
Examples of Support and Resistance to Trade Stocks
When you’re developing a plan using support and resistance to trade stocks, you should define these areas so you can practice proper risk management and identify potential target areas. Since the community mainly focused on buying stocks ahead of catalyst events, we identify support areas and will stop out if the price breaks below. Additionally, we’ll look at resistance areas to take profits. In other words, we’re looking for stocks to break out.
Here’s a look at a trading plan that uses support.
Esperion Therapeutics (ESPR) has Phase 3 data due out in August and September, so I’m looking to buy this ahead of this event for a 1 to 4 week hold. The stock has some support around $37, so I have a defined out.
My buy zone is between $39 to $41. My target is above $45.
Notice how ESPR has support around $37, and has rebounded off of that a few times already. That said, if this breaks below that area and I’m long the stock, I would just stop out.
Moving on, let’s take another look at how to use support and resistance to trade stocks.
Paratek (PRTK) has an FDA Approval date of October 4 with an Advisory Committee Meeting scheduled for August 8. After looking at the chart, it’s clear where to stop out and look to take profits. I’m looking to buy the stock between $10.40 and $10.80, which is slightly above the support area. Now, I would stop out if the stock price breaks below the support area around $10, so I’ll use $9.75 as my stop. My target is $12.50 or higher, and looking for a break above resistance.
Again, you could see the price rebound off of the $10 area, or support. Moreover, the $12 area is the resistance level, but I’m looking for the stock to gain some momentum. Thereafter, if it breaks above resistance, it could get into the gap and run to $12.50.
Let’s take a look at another example using support and resistance to trade stocks.
Catalyst Biosciences (CBIO) has a catalyst date in July and the company is releasing Phase II data. After looking at the chart, I could clearly identify the support and resistance areas. Consequently, I think this stock could run up ahead of the event. I’m looking to buy the stock anywhere between $24 and $26. My stop zone would be $22 or below, an area where the stock had a tough time breaking below. I’m looking for the stock to reach the resistance area and potentially break above it. I would take profits if the stock gets to $30 or higher.
If you get good at using support and resistance, you need to trade your own strategy. For example, if you found buying around support areas is profitable, don’t go out and start shorting at support. Trading is a process, and you need to learn over time what works best for you before you start experimenting.
Use Support and Resistance to Trade Stocks – The Bottom Line
Keep in mind, this isn’t a science and you don’t need to be precise with your prices. It’s trading stocks, and you need to take into account slippage. That said, you should continue practicing drawing support and resistance lines. It’s quite tedious at first, but once you get the hang of things you could start to use support and resistance to trade stocks. Thereafter, you could continue delving into technical analysis and use other indicators to trade stocks.
Kyle Dennis runs Kyle Dennis’ Biotech Breakouts (biotechbreakouts.com). He is an event-based trader, who prefers low-priced and small-cap biotech stocks. He’s also using his knowledge and looking to multiply his capital through options trades.