Episode #6 - Tutorial in Technical Analysis by Alan Hull July 14, 2023

This is another article in a series of education posts from Alan Hull. Alan Hull is a renowned technical analyst within the Australian Market. He has educated thousands of investors on how to apply technical analysis within their overall strategy. In this special series, Alan has agreed to share his Technical Analysis tutorials with Stockopedia members. He has committed to provide one ever three/four weeks. To learn more about Alan you can read his profile here. Or visit his website alanhull.com.au

To re-acquaint yourself with Alan's prior postings, please go to “Discuss” in the left hand column and selecting “Aus/NZBlogs” (see below). Scroll down and you will find a contribution one to every three/four weeks.

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Support and resistance

Previously we looked at both rising and falling trendlines but there’s another type of trendline which has a special significance…horizontal trendlines. And just like all other aspects of technical analysis, it’s very important to understand the behavioural basis behind horizontal trendlines if we are to use them effectively and with complete faith.

Imagine a share that trends up in price to 72 cents and then remains around 72 cents for an extended period of time. From this behavior it can be deduced that most of the recent buyers acquired their shares at or near a price of 72 cents.

If the price of the share rises from this level and then falls back to 72 cents, the large group of buyers at 72 cents will have enjoyed paper profits. Human greed will motivate them not to sell at or below 72 cents because of their recent profitable experience as they are now aware that the price can go higher. In doing so they provide support for the share at 72 cents by refraining from selling.

If the price of the share falls and then rises back to 72 cents, the 72 cent buyers typically become sellers at 72 cents. Fear motivates them to sell at the point where they can break even. In this case the 72 cent buyers, turned sellers, provide resistance to the share price at 72 cents.

Thus the price at which a share remains for an extended period of time takes on special significance. The price of 72 cents is said to be a level of support and resistance. On a bar chart you can position a horizontal line to represent the price level of support & resistance.

Placement of these lines is subjective and a chartist could position a support and resistance line on the following chart anywhere from 71 cents to 74 cents. Typically a chartist would put it right in the middle.

Support and resistance lines are projected forward into the future where the older the line, the less significant it becomes. However, the longer the price action remains at the same level, the more significant the support and resistance line becomes. Support and resistance lines, known henceforth as support/resistance or just S/R lines, are considered to be a primary tool for chartists.

Another behavioural reason for resistance is mass investor psychology. Thus we market participants will project resistance at key levels, such as when the All Ordinaries first rose to 3,000 points. Note in the following chart how the All Ords hesitated at this level for several weeks before breaking through.

When it comes to individual shares, market participants will often project resistance at currency levels such as $10.00, etc. Awareness of this phenomenon allows us to anticipate the market's behaviour at these key price levels.

Trends will often end at these key levels and therefore it is generally not wise to buy into shares as they approach them. Rather, it pays to wait until they have managed to breach these levels. An excellent example is when QBE Insurance first trended up towards $10...

You can see how the trend in the above chart of QBE began to weaken the moment it reached $10. Thus it would not have been prudent to enter the market at this time, given that there was an increased likelihood that the trend could come to an end. Instead, the chartist/trader would wait until this key price level had been eclipsed, as the following chart demonstrates…

Of course this means accepting a higher entry point into the market but it is my experience that it is a small price to pay for the increased likelihood of a trend continuation.

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