The authors have not found that an Average gap possessesany peculiar potency or significance over and above that attributable to agap in the chart of any actively and closely traded single issue.The broader, and hence, most representative market indexes show thefewest and smallest gaps. EN: On the other hand, the NASDAQ is quite volatileand a good gap producer.(It is suggested that the reader review this chapter after he has finishedstudying the principles of Support and Resistance in Chapter 13.)EN9: The truth is there is nothing more that need be said about gaps, and thetruth also is that no modern examples need be added. But gaps are fun, so see Figure114.1 and Chapter 16.1 for modern examples.
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chapter thirteen
Support and ResistanceThe phenomena that we shall study in this chapter are markedly differentin kind from those discussed in preceding sections. We shall look now at thestock market from a new angle, and in so doing may find it possible todevelop some very practical additional rules to guide us in selecting stocksfor purchase or sale, in estimating their potential moves, in foreseeing wherethey are likely to “run into trouble.” As a matter of fact, some experiencedtraders have built their “systems” almost entirely on the principles of whatwe here call Support and Resistance, paying no attention to the specificpictorial patterns of price and volume action we have been investigating inpreceding pages.But Support and Resistance phenomena are not, by any means, unrelatedto the various patterns and formations previously studied. We have alreadyhad occasion to hint at a basic principle of Support and Resistance in ourexplanation of gaps, and, as you read on, you will find that a number of theother patterns of price behavior are explained thereby, or at least becomemore readily understood.The term Support is commonly used in the Street. In one or more of itsconnotations, it must be fairly familiar to the reader. For example, we hearthat such-and-such a crowd is supporting XYZ at 50, or is prepared tosupport the market by buying all stock offered on any 5-point concession.For the purposes of this chapter, we may define Support as buying, actual orpotential, sufficient in volume to halt a downtrend in prices for an appreciable period. Resistance is the antithesis of Support; it is selling, actual orpotential, sufficient in volume to satisfy all bids and, hence, stop prices fromgoing higher for a time. Support and Resistance, as thus defined, are nearlybut not quite synonymous with demand and supply, respectively.A Support Level is a price level at which sufficient demand for a stockappears to hold a downtrend temporarily at least, and possibly reverse it,i.e., start prices moving up again. A Resistance Zone, by the same token, isa price level at which sufficient supply of a stock is forthcoming to stop, andpossibly turn back, its uptrend. There is, theoretically, a certain amount ofsupply and a certain amount of demand at any given price level. (The relativeamount of each will vary according to circumstances and determine thetrend.) But a Support Range represents a concentration of demand, and aResistance Range represents a concentration of supply.
231
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According to the foregoing definitions, you can see that the top boundaryof a Horizontal Congestion Pattern such as a Rectangle is a Resistance Level,and its bottom edge a Support Level; the top line of an Ascending Triangleis unmistakably a Resistance Level, etc. But we are more interested now inthe reasons why Support or Resistance, as the case may be, can be anticipatedto appear at certain price ranges. Within reasonable limits, and with a certainfew exceptions which we will examine later, it is quite possible to do this.Expert chart readers are able frequently to make some amazingly accuratepredictions as to where an advance will encounter Resistance (supply) orwhere a declining trend will meet Support.The basis for such predictions — the elementary data from which Support and Resistance theories are derived — is that turnover in any givenissue tends to be concentrated at the several price levels where a largenumber of shares changed hands in times past. Since any level at which agreat volume of transactions takes place usually becomes a Reversal point(Major, Intermediate, or Minor) in that stock’s trend, it follows naturally thatReversal Levels tend to “repeat.” But, here is the interesting and the important fact which, curiously enough, many casual chart observers appear neverto grasp: these critical price levels constantly switch their roles from Supportto Resistance and from Resistance to Support. A former Top, once it has beensurpassed, becomes a Bottom zone in a subsequent downtrend; and an oldBottom, once it has been penetrated, becomes a Top zone in a later advancingphase.
Normal Trend DevelopmentPerhaps we can make this plainer by citing a typical example of normaltrend development. Suppose a stock in a Bull Trend moves up from 12 to24, and there runs into a large volume of selling. The result is a reaction thatmay take the form of a full Intermediate Correction to, say, 18, or a series ofMinor Fluctuations forming a Consolidation Pattern between, say, 24 and21, the effect being the same in either case. Following this Correction orConsolidation, a new advance gets under way and carries price on up to 30before running again into supply in sufficient concentration to stifle themove. Now another reaction is evidently due. Again, it may take the formof a sideways Consolidation Pattern or an Intermediate Correction. If thelatter, where will that corrective setback be reversed; where, in other words,will it meet Support? The answer is at 24, the level of the first Top in thetrend. That is the level (below current quotations) where a large turnoverhad previously occurred. Then it functioned as Resistance, producing a haltor Reversal in the first upswing; now it functions as Support, stemming andreversing, at least in a Minor sense, the latest downswing.Why should this be? It will be easier to suggest an answer to thatquestion if we first go on with a similar example of typical action in adowntrend. This time, suppose our stock makes a Major Top and declinesfrom, say, 70 to 50. There, at 50, a temporary Selling Climax occurs; there is
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a large turnover, prices rally, perhaps slip back for a “test” of 50, and thenstage a good recovery to 60. At 60, buying peters out, the trend rounds over,turns down, and accelerates in renewed decline which carries to a new lowat 42. Again a wave of buying comes in, and a second recovery swing getsunder way. We can confidently expect that this recovery (from 42) will runinto strong Resistance at 50. The price level which functioned as a Supportfor the first phase of decline, now that it has been broken through downsideby the second phase, will reverse its role and function as Resistance to thesecond recovery move. The former Bottom level will now become a Top level.Here, we may ask again why this should be so, and now we can suggestan answer. In the example of downtrend action cited in the preceding paragraph, our stock first dropped to 50, ran into considerable volume there,reversed its trend and rallied to 60 with activity dwindling on the rise. A lotof shares changed hands at 50, and for every seller, there was, of course, abuyer. A few of those buyers may have been covering short positions and,having done so, had no further interest in the issue. Others, short-termtraders and professionals, may have purchased simply because they senseda temporary Bottom in the making and hoped to scalp a few points on theensuing rally; presumably, they (or at least some of them) took their profitsand were out before prices broke very far on the next decline But a majorityof those who acquired shares at 50, it is safe to say, did so because theythought the stock was cheap at that price, because they figured it had gonelow enough. Only a few months ago, it was selling above 70; surely it wasa bargain at 50 and could be picked up and put away “for the long term.”
The ExplanationImagine yourself, for the moment, in the place of those new owners. Theysee prices turn up, reach 55, 58, 60. Their judgment appears to have beenvindicated. They hang on. Then the rally peters out, and prices start to driftoff again, slipping to 57, 55, 52, finally 50. They are mildly concerned butstill convinced that the stock is a bargain at that price. Probably there ismomentary hesitation in the decline at 50, and then prices break on down.Briefly, there is hope that the break is only a shakeout to be recovered quickly,but that hope vanishes as the downtrend continues. Now our new ownersbegin to worry. Something has gone wrong. When the stock gets down below45, the former bargain doesn’t look so good. “Well, I guess I picked a lemonthat time, but I won’t take a loss in it. I’ll just wait until it gets back up to50 some day where I can get out even (except for expenses), and then theycan have it.” (Does it sound familiar, by any chance?)Take the opposite side of the picture — the uptrend process. You, alongwith many others, bought XYZ at 12, carried it up to 24, decided that wasplenty high for it, and cashed in. Thereupon XYZ reacted to 20, and youcongratulate yourself on your astuteness. But then, unexpectedly, it turnsaround and rushes up to 30. Now you don’t feel so smart; that was a betterstock than you gave it credit for being. You wish you had it back. You will
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52JONES & LAUGHLIN JL
1944–1947
48444038363432302826242220
Sales100’s5004003002001001944
1945
1946
1947
FIGURE 135. Why now was so much time spent, so much “work” done duringmid-1945 under 33–34? We cannot see it on this chart, but the previous monthlyhistory shows that the Bottoms of long Congestion Areas were made in this zone inlate 1939 and late 1940. These old Bottoms, representing Support, originally, wereable to produce some supply (Resistance) 5 years later. Once prices had workedthrough that supply, however, they were able to rise quickly to 44, and then theirsubsequent reaction found Support just where you might have expected — at 33–34.Support had turned to Resistance and then to Support again.We can skip over the next few swings which “followed the rules” and go on tothe change in the picture which came with the first notable violation of a SupportLevel in 1946. Prices had pushed up the first of February nearly to 54, well out abovethe Tops around 46, formed the previous November. The late February reactionshould have “caught Support” around 46 — but it didn’t; it crashed on down to the“round figure” 40. This was an ominous (although not necessarily “fatal”) development. Thereafter, a massive Symmetrical Triangle was formed and broke downsidein September.The first Panic Decline in the Bear Market is no respecter of Support Levels. Thisone was no exception, although it is noteworthy that prices “bounced” several timesfrom the important old 33–34 zone. By November, the Top Triangle’s measurementhad been exactly fulfilled.You should turn back to this record and study it again after you have read thenext 10 or 11 pages.
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not pay more for it, but if it comes back down to 24, the price at which yousold, you’ll “reinstate your position.”Perhaps you have never been in either of these situations. Perhaps yourown reactions wouldn’t, in such cases, have been the same as those we haveindicated. But, if you have had a fair amount of experience in the market —have some knowledge of the psychology of the “average investor” — youknow that the pictures we have described are typical.At this point you may not be satisfied that we have succeeded in givingan adequate explanation for our basic principle of Support and ResistanceLevels. Remember, however, that the supply and demand balance in themarket is nearly always a delicate thing. Only a moderate oversupply at anyone price will suffice to stifle an advance; only a little extra demand concentrated at a certain level will stem a decline. And remember, further, that othertraders are watching the tape — will be quick to sense any change in thesituation, and quick to join the parade whenever a change in trend appearsto be developing. Consequently, orders to buy or sell a few hundred sharesmay induce the transfer of several thousand.Another point worth bearing in mind is that the traders and investorswho (because, as we have presumed, of their previous mistakes in eitherselling or buying prematurely) created Support and Resistance Levels arenot necessarily ignorant or inexperienced. On the contrary, we must list themamong the wiser and more alert of those who operate in the market. To makeone more use of our previous theoretical example of typical downtrendaction, those who bought at 50 were certainly smarter than those who boughtat the top (70) or on the way down to 50, even though the latter price wasbroken later on. Giving them credit for somewhat superior judgment, itfollows that they may be expected to appraise later developments prettycarefully and display something better than a wooden and stubborn determination to “get out even” when it comes to selling on a Recovery Move.Hence, in a marked Bear Trend “overhanging supply”; i.e., stock boughtat higher levels by holders now waiting for a good chance to unload, willbegin to come on the market below the theoretical Resistance Level. Wiseowners will be willing to sacrifice a point or so to avoid getting caught ina worse loss.By the same token, “sold-out Bulls,” when a Major Uptrend is underway, may be willing to pay a point or two more in order to replace the sharesthey had previously cashed in too soon. Thus, it is characteristic of reactionsin well-established (second phase) Bull Markets to drop back only to thevery uppermost limits of a Support Range — and for recoveries in established Bear Markets to reach only the lowest edges of Resistance Zones, orperhaps even fail of that by an appreciable margin. We shall have more ofthis sort of thing to point out later on, but first we must take up two othermatters — how to estimate the potential importance of Support and Resistance Zones, and how to locate, more exactly, the centers of axes of suchzones.
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Estimating Support–Resistance PotentialTo go back to first principles, we have seen that the Resistance that an upwardmove may meet at any given level depends on the quantity of stock overhanging there — the number of shares previously bought at that price byowners who now would like to get out without loss. Obviously then, volumeis our first criterion in estimating the power of a Resistance Range. An oldMinor Bottom level at which only four or five hundred shares changed handscannot set up much Resistance to a subsequent advance, but a Selling ClimaxBottom where several thousand shares were bought will provide a lot ofpotential supply after prices, at some later date, have dropped well belowit, and then attempt to rise up through it again.A long Rectangle or a Descending Triangle has a number of Bottoms atthe same level. We can get a crude approximation of the amount of Resistancethere by summing up the volume of trading on all its Bottoms, but thensome discount must be taken for the shares that may have been bought atthe Bottom of the pattern in its early stages and then sold near the Top beforeit was completed. In brief, a single, sharp, high-volume Bottom offers somewhat more Resistance than a series of Bottoms with the same volume spreadout in time and with intervening rallies.Another criterion is the extent of the subsequent decline. Or, to put itanother way, how far prices will have to climb before they encounter the oldBottom zone whose Resistance potential we are attempting to appraise.Generally speaking, the greater the distance, the greater the Resistance.Suppose PDQ sells off from 30 to 20, “churns” at that level for several days,rallies to 24, and then drifts back down to 19. Investors who picked it up at20 will not be greatly concerned at that stage. If a rally now develops from19, there will be little or no disappointed selling at 20. Should prices dipto 18 before the rally starts, there may be some supply forthcoming at 20,but still not a formidable quantity. From 17, Resistance will become evident.In brief, prices have to break far enough below the price at which a traderbought his stock to convince him that he made a bad investment and,hence, that he should sell when he gets a chance to do so without too greata loss.It is impossible to formulate any precise rule or equation to define howfar a decline must proceed to set up Resistance above it. However, do notlook for much supply to come out of a Bottom level in the low-middle priceranges (20 to 35) unless the trend later takes quotations more than 10% underit. This 10% rule cannot be applied to very low-priced issues. A man maybuy a stock at 5 and see it drop to 4 or 3½ with considerable equanimitydespite the fact that he stands a loss of 30% at the latter figure. His “dollar”loss looks small, and he still thinks it will be easy for his stock to get backup to 6 or 7; he is willing to wait.Another factor enters into and reinforces the “extent of decline” criterion.If our PDQ rallies, as before, from 20 to 24 and then drops rapidly to 12, not
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56BENDIX AVIATION
BX
5248444038361944–1945
34Sales100’s5040302010J
F
M
A
M
J
J
A
S
O
N
D
J
F
M
A
M
J
FIGURE 136. Support–Resistance Levels in a long Intermediate Uptrend. The reader will need no guidance in applying the principles stated in this chapter to theBendix weekly chart reproduced above. Observe that when prices broke down in1945 through a long trendline, their decline stopped, nevertheless, at the Support setup by the previous November’s Top.
only will many of the old owners at 20 be thoroughly disgusted and gladto get out at that price, given an opportunity, but the new owners at 12 willalso be pleased to take 20 (66⅔% profit) and quick to do so if they detectany signs of trouble there. New buyers at 18, needless to say, would not bequite so ready to sell at 20.A third criterion for appraising the Resistance potential at an old Bottomlevel is the length of time that has elapsed since it was formed and the natureof general market developments in the interim. You will, no doubt, find itreasonable to suppose that an Intermediate Bottom formed in the early stagesof a Bear Market will offer relatively little Resistance after prices have fallenfar below it, have taken perhaps the better part of a year to make a Majorbase, and then have gradually climbed up to it again 4 or 5 years later. Tosome small extent, this is true. A supply only a year or two old is apt to bemore effective than one that is 4 or 5 years old, but the latter does not loseall of its potency by any means. In fact, it is often surprising how effectivethe Resistance will be at a very old Bottom zone, provided it has not been“attacked” in the interim, and provided no changes have been made in thecapitalization of the company which might obscure, in the mind of the owner,the original cost of his stock. Under the latter heading, we would put splitups and large stock dividends, or even an unusually generous cash “melon.”
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30
25
NATIONAL DISTILLERS DR
20
15
10
5
3 for 1
3 for 1
1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1947 1948
FIGURE 137. For Major Support–Resistance Level study, monthly charts are mostuseful. This one presents many points of interest. Observe how important levels areformed and how, once formed, they appear again, and reverse their roles. The pricescale shows 1947 values with previous years adjusted for the splits of 1933 and 1946.
We do not mean to imply that an investor is ever actually deceived as to theactual cost of his shares, no matter how they may have been split, or whatdividend distribution has been made, but his disappointment (and desire toget out even) may be abated.If, however, a Resistance Zone has once been attacked — if prices havecome back up to it, hit it, and then retreated — some of its power hasobviously been removed. Some of its overhanging supply has been used upin repelling the first attack. The next advance, therefore, will have less stockto absorb at that level. Here again, the volume chart may be looked to forsome approximation of the amount of Resistance consumed. In any event,it is an odds-on assumption that a third attack at a Resistance Level willsucceed in penetrating it.
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We have named three criteria — volume, distance away, and timeelapsed — to be used in assessing the amount of Resistance to be expectedat any given level. At this point, it must be apparent to the reader (andperhaps disappointing) that his own judgment must play a large role inapplying them. This cannot be helped. It is impossible to set up an exactmathematical formula for any of them.But, after all, the problem is not too complicated. The general principlesare simple enough and, we believe, easy to understand. We can look backat the charted history and see where, in the last preceding downtrend, aBottom formed that may produce more or less Resistance when the currentadvance reaches back up to its range. We have to estimate how much supplyresides there, how many shares were bought originally at that price and arestill held by owners who may welcome a chance to get out even.The greatest danger in applying judgment to the measuring of thesefactors lies in underestimating the amount of Resistance to be expected.Guard against that effort; it is safer always to overestimate it. You may beBullishly disposed yourself; you may say, “Those fellows who were hungup there in this stock must realize that conditions have improved, and theywill not be so anxious now to sell.” Don’t count on it. Remember that theyhave been “hung up” for a long time. Even if they are mildly Bullish on themarket in general, they may be so disappointed with this particular stockthat they want to switch out of it and try something else. (The stubborn andoften costly refusal of the average American investor to “take a loss” operateseven against timely switching.)Everything we have said in the foregoing paragraphs about estimatingpotential Resistance applies as well — but in a reverse direction, of course —to estimating potential Support. The principles are precisely the same, eventhough the underlying rationale may be less easy to grasp.
Locating Precise LevelsOur next problem to consider is how, in practical day-to-day chart analysis,we can locate as exactly as possible the limits of a Support or ResistanceRange, and in many cases, the specific price figure representing the core oraxis of such a range. In the theoretical examples we have made up so far toillustrate basic principles, we have used even figures, but in actual trading,the levels are seldom so nicely marked. Even the sharp and relatively patternless Bottom of a Recession may consist of a week of price fluctuationswithin a narrow range. Perhaps the lowest day of that week’s Congestionwill appear on the chart as a One-Day Reversal, or there will be 2 or 3 dayswhich “spike” down below the general mass. Here again, although no mathematical rule can be laid down, it is easy to relate the price and volumepatterns visually, and by simple inspection, arrive at a near estimate of thefigure at which supply in quantity is likely to be forthcoming. Look particularly at the closing levels of the days making up the Bottom Congestion,
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50
KRESGE (S.S.) CO.
KG
40
30
20
10Sales100’s8004001936
1937
1938
1939
1940
1941
1942
1943
1944
1945
1946
FIGURE 138. Particularly noteworthy in this monthly record is the Resistance metin 1939, 1940, 1941, and even in 1944, at the Bottom level (just above 26), the 3-monthCongestion of 1936. Also, the appearance 8 years later (!) in 1945 of Resistance at theBottom level (28) of the High-Volume Top Congestion of 1936–37.Prices were able to “skyrocket” when that Resistance was finally overcome. Youwill find that several additional Support–Resistance Lines might have been drawnon this chart. Note Major Bottom Formations of 1937–38 and 1942.
and average them mentally; this figure is apt to be pretty close to the “centerof gravity” of the entire Resistance Area.Of course, some supply is likely to start coming in as soon as a subsequent advance reaches the bottommost fraction of the Resistance Zone, andmore and more will appear as the move pushes up into it. Sometimes, it ispossible to predict “to a hair” just how far prices will penetrate a ResistanceRange by carefully comparing the vigor (volume of trading) on the advancewith the volume registered at various levels in the original formation of theResistance. This takes experience, but it is experience which you will findquite easy and not at all costly to gain. However, in most cases, it is neithernecessary nor particularly desirable to be so exacting.Nearly every chart in this book shows some example of Support andResistance phenomena, and the reader should make it a point, when he hasfinished this chapter, to go back over them and study them all in detail. Thepractical application of the rules we have been discussing will be greatlyclarified. Equally instructive, if you can manage to obtain such a collection,
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is a study of the Support and Resistance Levels appearing in the monthlycharts of all actively traded stocks over a period of 10 years or more. EN:Easily generated by most currently available software and on the Internet atprophet.net and stockcharts.com. You will undoubtedly be amazed to see howTops, Bottoms, and Sideways Congestions tend to form at the same approximate levels in successive Major Swings, while prices move freely and rapidly, up or down, through the ranges between such levels. It is hardlynecessary to dwell on the practical dollars-and-cents value of such information which may be derived from the chart history.And that brings up a matter that we may as well pause to considerhere — the kind of charts most useful for locating and appraising Supportand Resistance Levels. For near-term Minor Moves, the daily chart is naturally the only source of information, and a daily chart record that extendsback for a year or more may, if necessary, be used in the location of levelsof Intermediate Trend importance. The writers have found, however, that adaily chart does not give the perspective on the long range which one reallyneeds to determine Major and Intermediate Support and Resistance Zones.It is apt to overemphasize the potential of a recently set up Minor Support(or Resistance) Zone and obscure the importance of a true IntermediateLevel. For true perspective, a weekly chart, showing volume as well as priceranges, and covering at least the whole previous Major Bull and Bear cycle,is most desirable. Also, very good results can be obtained with a little studyand experience from monthly charts.To return to our study of Support phenomena, we have had severaloccasions to refer in previous chapters to a “normal” trend. What we havehad in mind might perhaps be better called an “ideal” trend, since, like somany other so-called normal things, it represents a pattern from which thefacts of experience frequently deviate. In stock trends, nevertheless, thisnormal or ideal appears as a fairly common pattern. If it is an uptrend, itconsists of a series of zigzags, each “zig” carrying prices to a new high andeach “zag” taking them back to the approximate top of the preceding “zig.”To illustrate with figures, up to 10, back to 6, up to 15, back to 10, up to 20,back to 15, up to 26, back to 20, etc. Such a move is what technicians referto as “self-correction” and regard as particularly sound and, hence, likely tobe continued. You can see that what it really represents is reaction to thenearest Minor Support Level following each step forward. If you becomeinterested in an issue with such a trend pattern, the normal return to aSupport produces a good place to buy.
Significance of Support FailureSooner or later, however, a normal Minor Wave Pattern is bound to be brokenup. This generally occurs in one of two ways (although there is an infinityof possible variations). In one, prices spurt away in an advance out of allproportion to the previous succession of up waves. Such a move is seldom
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60
JEWEL TEA CO.
JWT
52443628Sales100’s8040
2 for 1
1936
1937
1938
1939
1940
1941
1942
1943
1944
1945
1946
FIGURE 139. A monthly chart of Jewel Tea Company with its Major Support–Resistance Levels marked. Note reversal of roles.
followed by a reaction to the Support now left far behind, but rather, by theconstruction of some sort of Area Pattern — which may be either Consolidation or Reversal.The other type of disruption appears when a reaction