Chart Smarts: The Importance of Resistance Levels

“…The S&P 500 twice closed above 1,370, a closely watched technical resistance level,” says an article published yesterday on CNBC.com.

Wait, what the heck does that mean?

Resistance is one of those words that gets thrown around a lot by market professionals without much thought about whether or not most people really know what it means. I’ll admit that I’m guilty of that too. But today, I want to take a minute to explain exactly what resistance means in real terms — and show you a real-world resistance trade I just made with my premium readers to take home gains of 12.7% in less than a month.

Put simply, resistance is a price level that a stock has difficulty moving up through. In other words, it’s a “price ceiling” for shares. It only takes a minute to spot a resistance level on a price chart — you’re just looking for a price that shares consistently move up to then bounce lower off of.

At the end of the day, prices all come down to supply and demand. Resistance levels work because they’re prices where there’s a glut of supply of shares. They’re prices where sellers become more eager to sell than buyers are to buy. And as a trader, a stock’s behavior around a resistance level can have some big implications…

If a stock “breaks out”, and pushes above resistance, we know that buyers have absorbed all of that supply of shares that was causing the price to act like a barrier. Without that barrier, there’s room for shares to move higher. That’s why a breakout is a buy signal.

So, let’s take a look at a real-world example of a breakout trade that my Penny Momentum Trader readers just had a chance to book 12.7% on in the last month…

The stock in question was Charming Shoppes (NASDAQ: CHRS), a small-cap apparel stock that had a long-term resistance level just above $5. Try as they might, shares hadn’t been able to push above $5 for the better part of a year — that’s exactly why a breakout above $5 was such a big deal.

The video below is the analysis that I sent my readers back in February:

 



Shares shoved their way above $5.05, and we pulled the trigger on the trade on February 6. By March 1, shares had reached our price objective and we took gains of 12.7%. Along the way, this stock demonstrated an important characteristic of resistance levels: the fact that they become support levels — or price floors — once they’ve been exceeded.

All told, the completed trade looked like this:



Now that stocks are back in sustained rally mode, it’s becoming easier to spot tradable resistance levels in the market. That means that you can put this simple technique into practice to find profitable trades of your own — it’s as simple as bringing up a candlestick chart at a site like StockCharts.com, and looking for resistance levels in a handful of stocks.

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