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Trading Stocks Using Major Support

03/02/11 01:58:03 PM
by Billy Williams

There are three critical elements when trading stocks off of support levels. Do you know what they are?

Security:   GS
Position:   Hold

When a stock's price trends higher, at some point, the acceleration of the move begins to slow down as some traders begin to doubt whether the move can continue and/or just want to take profits. At this point in the trend cycle, price will begin to consolidate its price action and oscillate between two price points, forming a trading range.

These trading ranges are points of contraction within a stock's trend and, depending on the certain factors, will form major or minor support.

Major support is typically formed as a stock reaches a significant price high, usually an all-time high, that the market rejects and traders sell their positions at that point in a large-enough volume to cause the price to reverse lower. The decline is typically a steep decline, forcing short-term and intermediate-term investors and traders alike out of their positions to avoid further losses.

The low of that steep decline becomes the critical area where support will be confirmed as the low point is established and price begins to climb higher from that price low. However, buyers of the stock still don't have sufficient control of the stock's ascent and bearish traders force the stock down to the previous low point, which was set at the very low of the initial overall price decline.

Now, there are three factors to consider at this level: price, volume, and time. Price is the area at which the low of decline has been set and should be observed for a reaction or behavior that rejects further decline in price value of the stock. This is not an exact point but an area that centers around the area of the low point of the decline that is being retested by current price action. See Figure 1.

FIGURE 1: GOLDMAN SACHS. GS first showed confirmed support at point 1 when price retested a confirmed low on exhaustive trade volume, trading to an all-time high before a steep decline. The length of time from the last retest of support further confirmed major support at this price level at point 2 and again at point 3, resulting in price trading higher from these levels.
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The reason for this is because it is at this point where the decline was halted because there is a combination of both institutional and private investors or traders that are holding a position at this level, refusing to sell. They are the last holdouts and it is on their resolve that major support will be confirmed in a show of confidence by speculators that are observing from the sidelines and waiting for an opportunity to exploit a resumption of the uptrend.

The factor of price also includes a count of each time that price has touched a level of support where price's move downward was rejected, sending the stock higher from that point of contact and confirming major support is in place and holding.

Volume is to trading stocks what rocket fuel is to the space shuttle; it is the catalyst for price movement in a stock. It reveals the participation in a stock's move by the buyers and sellers in the market and give an indication of a breakout to higher or lower price levels or that a given move has exhausted itself, indicating a possible price reversal.

Time is the final factor that confirms major support and applies to how long a stock's price action has been in a period of contraction. If a stock has been in a trading range for two months, then that is a superior condition for major support to hold than if it had been just two weeks. The markets, like people, are prone to inertia unless a larger, stronger force from the outside acts upon it and forces it out of its static condition. In this case, a larger force could be a large institution selling off a large position in bulk, causing selling volume to surge and forcing the value of the stock through a level of major support.

Major support is one of the stalwarts of successful trading that has been used for decades, and using these three factors to assess a trade setup at these critical areas will help you profit and avoid low-probability conditions where profitable moves are in doubt.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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Date: 03/08/11Rank: 5Comment: 

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