Support and resistance lines

Support and resistance represent key junctures where the forces of supply and demand
meet. These lines appear as thresholds to price patterns. They are the respective lines
which stops the prices from decreasing or increasing.

A support line refers to that level beyond which a stock’s price will not fall. It denotes that
price level at which there is a sufficient amount of demand to stop and possibly, for a time,
turn a downtrend higher.

Similarly a resistance line refers to that line beyond which a stock’s price will not increase. It
indicates that price level at which a sufficient supply of stock is available to stop and
possibly, for a time, head off an uptrend in prices.

Trend lines are often referred to as support and resistance lines on an angle.

Support

A support is a horizontal floor where interest in buying a commodity is strong enough to

overcome the pressure to sell. Support level is the price level at which sufficient demand
exists to, at least temporarily, halt a downward movement in prices. Logically as the price
declines towards support and gets cheaper, buyers become more inclined to buy and sellers
become less inclined to sell. By the time the price reaches the support level, it is believed
that demand will overcome supply and prevent the price from falling below support.

Support does not always hold true and a break below support signals that the bulls have lost
over the bears. A fall below support level indicates more willingness to sell and a lack of
willingness to buy. A break in the levels of support indicates that the expectations of sellers
are reducing and they are ready to sell at even lower prices. In addition, buyers could not
be coerced into buying until prices declined below support or below the previous low. Once
support is broken, another support level will have to be established at a lower level

Resistance

A resistance is a horizontal ceiling where the pressure to sell is greater than the pressure to
buy. Thus a Resistance level is a price at which sufficient supply exists to; at least
temporarily, halt an upward movement. Logically as the price advances towards resistance,
sellers become more inclined to sell and buyers become less inclined to buy. By the time the
price reaches the resistance level, it is believed that supply will overcome demand and
prevent the price from rising above resistance.

Resistance does not always hold true and a break above resistance signals that the bears
have lost over the bulls. A break in the resistance level shows more willingness to buy or
lack of incentive to sell. Resistance breaks and new highs indicate that buyer’s expectations
have increased and are ready to buy at even higher prices. In addition, sellers could not be
coerced into selling until prices rose above resistance or above the previous high. Once
resistance is broken, another resistance level will have to be established at a higher level.
 How to Calculate Resistance and Support Level

Pivot Point(P)= {Low+High+Close} [all of Last Day ]/3

1. First resistance (R1) = (2 x PP) – Low.

First support (S1) = (2 x PP) – High.

2. Second resistance (R2) = PP + (High – Low)

Second support (S2) = PP – (High – Low)

3. Third resistance (R3) = High + 2(PP – Low)

Third support (S3) = Low – 2(High – PP)

Head and Shoulders

The head and shoulders pattern can be either head and shoulders, top or head and
shoulders bottom. The Charts are a picture of a head and shoulders movement, which
portrays three successive rallies and reactions with the second one making the
highest/lowest point.
Head and Shoulders (Top reversal)
A Head and Shoulders (Top) is a reversal pattern which occurs following an extended
uptrend forms and its completion marks a trend reversal. The pattern contains three
successive peaks with the middle peak (head) being the highest and the two outside peaks
(shoulders) being low and roughly equal. The reaction lows of each peak can be connected
to form support, or a neckline. As its name implies, the head and shoulders reversal pattern
is made up of a left shoulder, head, right shoulder, and neckline. Other parts playing a role
in the pattern are volume, the breakout, price target and support turned resistance. Lets
look at each part individually, and then put them together with some example

1. Prior trend: It is important to establish the existence of a prior uptrend for this to be a
reversal pattern. Without a prior uptrend to reverse, there cannot be a head and shoulders
reversal pattern, or any reversal pattern for that matter.

2. Left shoulder: While in an uptrend, the left shoulder forms a peak that marks the high
point of the current trend. It is formed usually at the end of an extensive advance during
which volume is quite heavy. At the end of the left shoulder there is usually a dip or
recession which typically occurs on low volume.

3. Head: From the low of the left shoulder, an advance begins that exceeds the previous
high and marks the top of the head. At this point, in order conform to proper form, prices
must come down somewhere near the low of the left shoulder –somewhat lower perhaps or
somewhat higher but in any case, below the top of the left shoulder.

4. Right shoulder: The right shoulder is formed when the low of the head advances again.
The peak of the right shoulder is almost equal in height to that of the left shoulder but lower
than the head. While symmetry is preferred, sometimes the shoulders can be out of whack.
The decline from the peak of the right shoulder should break the neckline.

5. Neckline: A neckline can be drawn across the bottoms of the left shoulder, the head and
the right shoulder. A breaking of this neckline on a decline from the right shoulder is the
final confirmation and completes the head and shoulder formation.

6. Volume: As the head and shoulders pattern unfolds, volume plays an important role in
confirmation. Volume can be measured as an indicator or simply by analyzing volume levels.
Ideally, but not always, volume during the advance of the left shoulder should be higher
than during the advance of the head. These decreases in volume along with new highs that
form the head serve as a warning sign. The next warning sign comes when volume increases
on the decline from the peak of the head. Final confirmation comes when volume further
increases during the decline of the right shoulder.

7. Neckline break: The head and shoulders pattern is said to be complete only when the
neckline support is broken. Ideally, this should also occur in a convincing manner with an
expansion in volume.

8. Support turned resistance: Once support is broken, it is common for this same support
level to turn into resistance. Sometimes, but certainly not always, the price will return to the
support break, and offer a second chance to sell.

9. Price target: After breaking neckline support, the projected price decline is found by
measuring the distance from the neckline to the top of the head. Price target is calculated
by subtracting the above distance from the neckline. Any price target should serve as a
rough guide, and other factors such as previous support levels should be considered as well.

Signals generated by head and shoulder pattern

• The support line is based on points B and C.
• The resistance line. After giving in at point D, the market may retest the neckline at point
E.
• The price direction. If the neckline holds the buying pressure at point E, then the formation
provides information regarding the price direction: diametrically opposed to the direction
of the head-and-shoulders (bearish).
• The price target D to F. This is provided by the confi rmation of the formation (by breaking
through the neckline under heavy trading volume). This is equal to the range from top of
the head to neckline.

Some important points to remember

• The head and shoulders pattern is one of the most common reversal formations. It
occurs after an uptrend and usually marks a major trend reversal when complete.

• It is preferable that the left and right shoulders be symmetrical, it is not an absolute
requirement. They can be different widths as well as different heights.

• Volume support and neckline support identifi cation are considered to be the most critical
factors. The support break indicates a new willingness to sell at lower prices. There is an
increase in supply combined with lower prices and increasing volume .The combination
can be lethal, and sometimes, there is no second chance return to the support break.

• Measuring the expected length of the decline after the breakout can be helpful, but it
is not always necessary target. As the pattern unfolds over time, other aspects of the
technical picture are likely to take precedence.

Inverted head and shoulders

The head and shoulders bottom is the inverse of the H&S Top. In the chart below, after a
period, the downward trend reaches a climax, which is followed by a rally that tends to carry
the share back approximately to the neckline. After a decline below the previous low
followed by a rally, the head is formed. This is followed by the third decline which fails to
reach the previous low. The advance from this point continues across the neckline and
constitutes the breakthrough.

The main difference between this and the Head and Shoulders Top is in the volume
pattern
associated with the share price movements. The volume should increase with the increase in
the price from the bottom of the head and then it should start increasing even more on the
rally which is followed by the right shoulder. If the neckline is broken but volume is low, you
should be skeptical about the validity of the formation.

As a major reversal pattern, the head and shoulders bottom forms after a downtrend, and its
completion marks a change in trend. The pattern contains three troughs in successive
manner with the two outside troughs namely the right and the shoulder being lower in
height than the middle trough (head) which is the deepest. Ideally, the two shoulders i.e. the
right and the left shoulder should be equal in height and width. The reaction highs in the
middle of the pattern can be connected to form resistance, or a neckline.

Double tops and bottoms

These are considered to be among the most familiar of all chart patterns and often signal
turning points, or reversals. The double top resembles the letter “M”. Conversely, the double
bottom resembles a “W” formation; in reverse of the double top.

Double top
It is a term used in technical analysis to describe the rise of a stock, a drop and another rise
roughly of the same level as the previous top and fi nally followed by another drop.
A double top is a reversal pattern which occurs following an extended uptrend. This name
is given to the pair of peaks which is formed when price is unable to reach a new high. It is
desirable to sell when the price breaks below the reaction low that is formed between the
two peaks.

Context: The double top must be followed by an extended price rise or uptrend. The two
peaks formed need not be equal in price, but should be same in the area with a minor
reaction low between them. This is a reliable indicator of a potential reversal to the
downside.

Appearance: Price moves higher and forms a new high. This is followed by a downside
retracement, which forms a reaction low before one final low-volume assault is made on the
area of the recent high. In some cases the previous high is never reached, and sometimes it
is briefly but does not hold. This pattern is said to be complete once price makes the second
peak and then penetrates the lowest point between the highs, called the reaction low. The
sell indication from this topping pattern occurs when price breaks the reaction low to the
downside.

Breakout expectation: When the reaction low is penetrated to the downside,

accompanied by
expanding volume the double top pattern becomes official. Downside price target is
calculated by subtracting the distance from the reaction low to the peak from the reaction
low. Often times a double top will mark a lasting top and lead to a signifi cant decline which
exceeds the price target to the downside.
Although there can be variations but if the trend is from bullish to bearish, the classic double
top will mark at least an intermediate change, if not long-term change. Many potential
double tops can form along the way up, but until key support is broken, a reversal cannot
be confirmed.

1. Prior trend: With any reversal pattern, there must be an existing trend to reverse. In
the case of the double top, a signifi cant uptrend of several months should be in place.

2. First peak: The fi rst peak marks the highest point of the current trend.

3. Trough: Once the fi rst peak is reached, a decline takes place that typically ranges from
10-20%. The lows are sometimes rounded or drawn out a bit, which can be a sign of tepid
demand.

4. Second peak: The advance off the lows usually occurs with low volume and meets
resistance from the previous high. Resistance from the previous high should be expected
and after the resistance is met, only the possibility of a double top exists. The pattern still
needs to be confirmed. The time period between peaks can vary from a few weeks to many
months, with the norm being 1-3 months. While exact peaks are preferable, there is some
leeway.
Usually a peak within 3% of the previous high is adequate.

5. Decline from peak: Decline in the second peak is witnessed by an expanding volume
and/or an accelerated descent, perhaps marked with a gap or two. Such a decline shows
that the forces of supply are stronger than the forces of demand and a support test is
imminent.

6. Support break: The double top and trend reversal are not complete even when the
trading till the support is done. The double top pattern is said to be complete when the
support breaks from the lowest point between the peaks. This too should occur with an
increase in volume and/or an accelerated descent.

7. Support turned resistance: Broken support becomes potential resistance and there is
sometimes a test of this newfound resistance level with a reaction rally

8. Price target: Price target is calculated by subtracting the distance from the support
break to peak from the support break. The larger the potential decline the bigger will be the
formation.

Double bottom

Double bottom is a charting technique used in technical analysis. It is used to describe a

drop in the value of a stock (index), bounces back and then another drop to the similar level
as the previous low and fi nally rebounds again. A double bottom is a reversal pattern which
occurs following an extended downtrend. The buy signal is when price breaks above the
reaction high which is formed between the two lows.

Context: The double bottom must be followed by an extended decline in prices. The two
lows
formed have to be equal in areas with a minor reaction high between them, though they
need not to be equal in price. This is a reliable indicator of a potential reversal to the upside.

Appearance: Price reduces further to form a new low. This is followed by upside
retracement or minor bounce, which forms a reaction high before one final low-volume
downward push is made to the area of the recent low. In some cases the previous low is
never reached, while in others it is briefly penetrated to the downside, but price does not
remain below it. This pattern is considered complete once price makes the second low and
then penetrates the highest point between the lows, called the reaction high. The buy
indication from this bottom pattern occurs when price breaks the reaction high to the
upside.

Breakout expectation: A double bottom pattern becomes official when the reaction high is
penetrated to the upside, ideally accompanied by expanding volume. Upside price target is
calculated adding the distance from the reaction high to the low to that of reaction high.
Often times a double bottom will mark a lasting low and lead to a significant price advance
which exceeds the price target to the upside. There can be many variations that can occur in
the double bottom, but the classic double bottom usually marks an intermediate or a long-
term change in trend. Many potential double bottoms can be formed along the way down,
but a reversal cannot be confi rmed until key resistance is broken.

Rounded top and bottom

Another shape which a top and bottom can take is one in which the reversal is “rounded”.
The rounded bottom formation forms when the market gradually yet steadily shifts from a
bearish to bullish outlook while in the case of a rounded top, from bullish to bearish.
The Rounded Top formation consists of a gradual change in trend from up to down.

The Rounded Bottom formation consists of a gradual change in trend from down to up. This
formation is the exact opposite of a Rounded Top Formation. The prices take on a bowl
shaped pattern as the market slowly and casually changes from an upward to a downward
trend.

It is very (remove) considered very difficult to separate a rounded bottom, where the price
continues to decrease from a consolidation pattern and where price stays at a level, but the
clue, as always, is in volume. In a true Rounded Bottom, the volume decreases as the
price decreases, this signifies a decrease in the selling pressure. A very little trading
activity can be seen when the price movement becomes neutral and goes sideways and the
volumes are also low. Then, as prices start to increase, the volume increases.

Flags
Flags are constructed using two parallel trendlines that can slope up, down or
sideways (horizontal). In general, a flag that has an upward slope appears as a
pause in a down trending market; a flag with a downward bias shows a break
during an up trending market. Typically, the formation of the flag is accompanied
by a period of declining volume, which recovers as price breaks out of the flag
formation.

Wedges
Wedges are similar to pennants in that they are drawn using two converging
trendlines; however, a wedge is characterized by the fact that both trendlines are
moving in the same direction, either up or down. A wedge that is angled down
represents a pause during a uptrend; a wedge that is angled up shows a temporary
interruption during a falling market. As with pennants and flags, volume typically
tapers off during the formation of the pattern, only to increase once price breaks
above or below the wedge pattern.
Triangles
Triangles are among the most popular chart patterns used in technical
analysis since they occur frequently compared to other patterns. The three most
common types of triangles are symmetrical triangles, ascending triangles,
and descending triangles. These chart patterns can last anywhere from a couple of
weeks to several months.

Symmetrical triangles occur when two trend lines converge toward each other and
signal only that a breakout is likely to occur—not the direction. Ascending
triangles are characterized by a flat upper trend line and a rising lower trend line
and suggest a breakout higher is likely, while descending triangles have a flat
lower trend line and a descending upper trend line that suggests a breakdown is
likely to occur. The magnitude of the breakouts or breakdowns is typically the
same as the height of the left vertical side of the triangle, as shown in the figure
below.
Cup and Handles
The cup and handle is a bullish continuation pattern where an upward trend has
paused, but will continue when the pattern is confirmed. The "cup" portion of the
pattern should be a "U" shape that resembles the rounding of a bowl rather than a
"V" shape with equal highs on both sides of the cup.

The "handle" forms on the right side of the cup in the form of a short pullback that
resembles a flag or pennant chart pattern. Once the handle is complete, the stock
may breakout to new highs and resume its trend higher. A cup and handle is
depicted in the figure below.
Gap theory
A gap is an area on a price chart in which there were no trades. Normally this occurs after
the close of the market on one day and the next day’s open. Lot’s of things can cause this,
such as an earnings report coming out after the stock market had closed for the day. If the
earnings were significantly higher than expected, this could result in the price opening
higher than the previous day’s close. If the trading that day continues to trade above that
point, a gap will exist in the price chart. Gaps can offer evidence that something important
has happened to the fundamentals or the psychology of the crowd that accompanies this
market movement.
Gaps appear more frequently on daily charts, where every day is an opportunity to create an
opening gap. Gaps can be subdivided into four basic categories:
• Common gap
• Breakaway gap
• Runaway/ Continuation gap
• Exhaustion gap

Common gaps
Sometimes referred to as a trading gap or an area gap, the common gap is usually
uneventful. This gap occurs characteristically in nervous markets and is generally closed
within few days. In fact, they can be caused by a stock going ex-dividend when the trading
volume is low.
A common gap usually appears in a trading range or congestion area and reinforces the
apparent lack of interest in the stock at that time. Many times this is further exacerbated by
low trading volume. Being aware of these types of gaps is good, but doubtful that they will
produce trading opportunities.

Breakaway gaps

Breakaway gaps are the exciting ones. They occur when the price action is breaking out of
their trading range or congestion area. To understand gaps, one has to understand the
nature of congestion areas in the market. A congestion area is just a price range in which
the market has traded for some period of time, usually a few weeks or so. The area near the
top of the congestion area is usually resistance when approached from below. Likewise, the
area near the bottom of the congestion area is support when approached from above. To
break out of these areas requires market enthusiasm and either many more buyers than
sellers for upside breakouts or more sellers than buyers for downside breakouts.

Runaway gaps

Runaway gaps are also called measuring gaps and are best described as gaps that are
caused by increased interest in the stock. For runaway gaps to the upside, it usually
represents traders who did not get in during the initial move of the uptrend and while
waiting for a retracement in price, decided it was not going to happen. Increased buying
interest happens all of a sudden and the price gaps above the previous day’s close. This
type of runaway gap represents an almost panic state in traders. Also, a good uptrend can
have runaway gaps caused by significant news events that cause new interest in the stock.

Runaway gaps can also happen in down trends. This usually represents increased liquidation
of that stock by traders and buyers who are standing on the sidelines.

Exhaustion gaps
Exhaustion gaps are those that happen near the end of a good up or down trend. They are
many times the fi rst signal of the end of that move. They are identified by high volume and
large price difference between the previous day’s close and the new opening price. They can
easily be mistaken for runaway gaps if one does not notice the exceptionally high volume.

It is almost a state of panic if during a long down move pessimism has set in. Selling all
positions to liquidate holdings in the market is not uncommon. Exhaustion gaps are quickly
filled as prices reverse their trend. Likewise if they happen during a bull move, some bullish
euphoria overcomes trades and they cannot get enough of that stock. The prices gap up
with huge volume, then there is great profit taking and the demand for the stock totally
dries up. Prices drop and a significant change in trend occurs.

Exhaustion gaps are probably the easiest to trade and profit from.