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Support and Resistance: Technical Analysis Primer

Ultimately, market prices are determined by what investors are willing to pay, supply and demand. If a stock is trading higher (in a phenomenon known as a trend), it can come across a pocket of supply that completely absorbs buyers' bid prices. When that happens, the uptrend halts as trades get filled at the same price level -- a price that's now become resistance. With all of that overhead supply, it's impossible for share prices to move higher under the calm, steady buying that had previously helped shares rise. Support works much the same way, except that support levels occur where there is a glut of demand for shares that absorbs all of the ask activity for the stock.

Fundamental investors often have difficulty coming to terms with the idea that past prices can have an impact on future prices. But as anyone who's ever owned a stock can probably attest, watching your position change in value is hard to ignore. It's naive to think that those past prices (like investors' entry prices) don't have an impact on when they ultimately choose to sell.

How to Spot Support and Resistance Levels

Generally, there are three ways that technical traders determine support and resistance levels: intermediate reversals, round numbers and moving averages .

Above: Intermediate peaks connected on shares of TSP reveal a staunch resistance level at $25.50.

The most common way to find support or resistance levels is by looking at intermediate reversals -- in other words, the points where trends have turned around and changed direction in the past. By connecting those peaks, you can draw a support or resistance line that restricts a stock's price action. These types of support and resistance can be either horizontal (at a set price level) or sloping trends.

Because investor psychology ultimately sets the market, round numbers can also act as important support and resistance levels. That's because when a stock approaches a round number, such as $10 or $100, investors have preconceived notions that the stock may be getting "expensive" or "cheap," prompting them to sell or buy shares accordingly. This can lead to broken trends at these prices.

Moving averages are also important indicators of support and resistance levels. Because they represent the average prices paid by investors for a given issue over a certain period, the psychological impact of a moving average can be tangible. When it comes to picking the appropriate moving average, some experimentation is sometimes required to find the MA that best restricts price action. (For more on moving averages, check out " Making Sense of Moving Averages.")

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