Support and Resistance Reversals

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Support and Resistance Reversals

Many technical analysts hear statements like “broken support level will become future region of resistance” or “past level of resistance will become support.” For new traders, sentences like these seem to be uttered in another language, and many veteran traders never really get or appreciate this exciting role reversal. This essay will seek to shed light on the significance of support and resistance levels, as well as why traders should pay close attention when they switch positions.

The Basics

To grasp the role reversal between support and resistance, you must first understand these fundamental principles. Technical traders use the phrases support and resistance to refer to key price levels that have historically stopped traders from moving the price of an underlying asset in a particular direction.

Assume ABC stock has tried to fall below an ascending trendline numerous times in the last several months, but despite approaching this line multiple times, it has failed to slip below it. In this situation, the trendline is referred to be a support level because it corresponds to a price level at which most investors feel safe purchasing the asset, preventing the market from driving prices further lower. Traders, on the other hand, use resistance to explain when the price of an item has trouble going over a specific price level, causing the asset’s price to fall.

The Reversal

One of the most intriguing support and resistance occurrences happens when the price of the underlying asset ultimately breaks out and goes beyond a specified support or resistance level. When this occurs, it is not unusual for a prior level of support to shift and become a new source of short-term resistance. The dotted line depicts the price that was able to hold up the price movement at points 1 and 2, but this support becomes resistance as the price goes below it, as seen by points 3 and 4.

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Support becomes resistance. Image by Sabrina Jiang © Investopedia2020

When the price breaks over resistance, the process reverses. Points 1 and 2 begin as price obstacles, but as the bulls are able to push the price over the dotted line, they become a region of support (illustrated by points 3 and 4).

Resistance becomes support. Image by Sabrina Jiang © Investopedia2020

Does This Really Happen?

Many traders who read about the shifting roles of support and resistance are dubious and do not trust that the notions shown in the theoretical figures above truly occur. Reversals, on the other hand, occur regularly, even on charts of the stock market’s largest names, such as ExxonMobil, Walmart, and even the Dow Jones Industrial Average (DJIA).

Let’s take a look at some real-world instances from a few years back. As seen in the graph below, the bulls were able to prevent the DJIA from falling below the trendline throughout the first few months of 2006, but this rise came to an end when the index closed below the trendline’s support on May 17, 2006. Traders saw the break below the trendline as an indication that the old support would become an area of resistance if the bulls responded by driving the price upward again. As you can see, the broken trendline created a point of resistance and was a big reason in the subsequent 5% drop.

DJIA falls below its support on May 17, 2006. Image by Sabrina Jiang © Investopedia2020

In the picture below, another fascinating illustration of the role reversal phenomena can be observed on the chart of oil giant Exon-Mobil (XOM). Take note of how the $65 level stopped the share price from rising on two distinct times during the 2005-2006 fiscal year. Following the break over the $65 barrier in mid-July 2006, the prior $65 resistance became support. In this situation, technical traders would have a positive attitude on this stock till XOM fell below the new support of $65, in which case they would seek for the prior support to become resistance again.

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XOM breaks out above the $65 resistance. Image by Sabrina Jiang © Investopedia2020

The last Walmart Inc. (WMT) example is similar to the XOM chart in that both show how a support/resistance level may alter its position on some of the most closely watched businesses on the stock market. The $51 level, as seen in the example below, stopped the bears from driving the price of Walmart shares lower for much of 2004, but it rapidly became resistance after the bears drove the shares below it in early 2005. Many technical traders continued to pay careful attention to Walmart as the share price reached $51 throughout the bulk of 2006 since this level has shown to be a significant element influencing the long-term direction of Walmart’s share price.

WMT falls below the $51 support in 2005. Image by Sabrina Jiang © Investopedia2020

The Bottom Line

Early in their careers, many technical or other short-term traders learn about support and resistance levels. However, some of these traders never completely grasp or comprehend the fascinating role reversal that happens when the price of an underlying asset exceeds one of these important thresholds. The notion of reversing roles has its detractors who do not think it exists in the real world, however as seen above, this phenomena can be found on the charts of some of the most well-known names in the stock market.

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