Support and Resistance Zones

Almost a year has passed since I wrote an introductory article describing the basics of both Support and Resistance. Much has happened in the markets since that early piece was offered up for investors venturing into the world of technical analysis for the first time. When most sectors are continuing on what appears to be a never-ending downward trendline, it is time to revisit support and resistance indicators, which could help you call the all-important entry and/or exit points when the markets make the turn northward.

We know that issues will trade between support and resistance. We also know that if the support or resistance does not have a significant volume number attached to it, that in most cases, the stock price will not break through the support or resistance line. This article examines how to measure the amount of support and resistance in our charts that will help to make our buy/sell decisions more effective. And we are going to learn how to measure overhead supply.

Support and resistance have been thought of as zones versus finite points. If a chartist draws a horizontal line at what appears to be the resistance at $15, the resistance may not be broken as the stock price moves to $16. In fact, the zone around the $15.00 mark should be studied closely. Resistance, in this hypothetical situation could be from $14 to the $16 mark. How would we know how to recognize a zone and how could we measure it? The answer is volume.

Volume plays the key role in the understanding of these zones. To demonstrate whether or not support and resistance will hold up when tested, let’s have a look at this 2001-2002 chart of Daktronics (DAKT).

Chart Created with Tradestation

Daktronics Inc. is a designer, marketer and manufacturer of state-of-the-art electronic scoreboards and freeway overhead signage. The stock, as you can see in the chart, traded up to $17 in early summer of 2001 and fell off dramatically on Jul 13 and again on Oct 11 to settle in between $6 and $7. Over the next month or so the price action slowly moved upward to the support line at $8, trading between $8 and $9 for about two months at the end of 2001 (Nov 14 to Jan 16).

During that period, the average daily volume was 32,000 shares per day for a total of about 1,280,000 shares. At that point the stock price tumbled again to the $6 level leaving some shareholders holding about 1.3 million shares at the $8-to-$9 price range for as much as a 33% loss. The 1.3 million shares are referred to as "overhead supply". Look closely at this time period between the middle of November and middle of January, because the shares purchased during this time stood to play an important role in the formation of the next uptrend.

Many of the shareholders from this time frame and price action had well been sellers when the stock price came back to the break-even level, putting a tremendous amount of pressure on the ability for the price action to move through the $8-to-$9 zone and break new ground. On Mar 22, the stock price closed back above $8 for the first time since mid Jan, and a study of the volume showed that over the next 15 trading sessions, half of the overhead supply was traded as well. Having said this, there was still about 650,000 shares left in the hands of investors, suggesting they had a long-term outlook and a minor slide for a couple of months had not been enough for them to sell their positions at the break-even level. It should be noted that it took a strong volume day of 179,600 shares traded for DAKT to move through the $9 zone, and another 160,000 over the next two trading sessions to sustain the stock price at that level.

So, an investor can quantify the overhead supply by adding the volume at the previous bottom. It is this number that investors should take into account as the stock price heads north. It is this number that will play a very important role in determining whether or not resistance will be broken. I the play does not have the volume necessary to break through into new ground, the stock price may just bounce off the resistance line and continue to decline in price.