How Becomes a Support Level

When a Resistance Level is Breached, It Becomes a Support Level

In technical analysis, there are some simple basic rules. One is that when a resistance level has been breached during an uptrend; it will now act as sup­port upon any pullbacks. Armed with that little tidbit of knowledge, analyzing price movements becomes a little clearer. Fig. 3-3, The NetGear, Inc. chart illustrates the support concept as well as a few other simple rules when using moving averages.

Another rule can be applied a majority of the time. When a price tests an important technical level the first time, it will usually fail. However; if it comes back up to test that level again, it will often go through. Notice in the NetGear Inc. chart the last day of July showed a gap up. It formed a Doji just above the 50-day moving average. The uptrend had a hard time continuing the first time it tested the 50-day moving average. As can be seen with the pullback into mid- August. It was then followed by a second test of the 50-day moving average. The advantage of the candlestick signals is that they reveal what the investor sentiment is doing right at those important levels. The second test of the 50- day moving average occurred when the strong bullish candle went through. That revealed the moving average was not going to be a resistance point. If the 50-day moving average is no longer a resistance point, what becomes the next target? The 200-day moving average!

Notice how the 200-day moving average was first tested on September 1. The failure at that level was indicated by a Doji/Harami showing the buying had stopped. This occurring, with the stochastics in the overbought area start­ing to turn back down, becomes a clear indication the sentiment failed to take prices up through the 200-day moving average. That would be an excellent time to take profits. The next push went through but failed just above the 200- day moving average with the appearance of a Bearish Engulfing signal.

When a moving average fails, what is the next target? The other major moving average! The 50-day moving average now becomes a likely target. This either provides a good short situation or allows an investor to take profits and wait to see what signals will form once the 50-day moving average is touched. As illustrated in this case, when prices got back to the 50-day moving average, a Bullish Harami formed as the stochastics reach the oversold area and started to curl back up. Now what becomes the next target? The 200-day moving average again.

The congestion area from that point remains fairly close to the 200-day moving average. The Piercing Pattern occurring when the 50-day MA crossed the 200-day MA produces important information. As can be seen, that signal, occurring at the intersection of the two major moving averages, was a signifi­cant factor in the next strong move upwards. After the initial buying, note how the pullback, with the Doji signal just touching the 50-day moving average, was followed by a Bullish Engulfing pattern that started the strong buying. The analysis of this chart provides a format for when to be looking for significant candlestick signals.

Fig. 3-3a, Cabot Microelectronics Corp. also reveals a failure of the 50-day moving average on July 1, only to come back up through the 50-day moving average with force in the latter part of July. After the initial run up, coming up through the 50-day moving average it pulled back. Notice how it supported exactly on the moving average line before the Bullish Engulfing signal revealed that buying was not going to take the price any lower.

Where did the first major resistance come into play? At the 200-day moving average in mid-September! When it fails the 200-day moving average, where is the potential pullback target? The 50-day moving average! The Bullish Engulf­ing signal at that level indicates the next target is the 200-day moving average again. Once there, the evening star signal reveals another failure of the 200- day moving average.

Notice there is a definite candlestick signal right at the major averages. Once again, it does not take too long to realize that the moving averages are important targets. It was also easy to evaluate what was happening at those targets with the identification of candlestick signals.

Fig. 3-4, the Alamosa Holding Inc. chart also reveals the importance of a major moving average acting as a substantial indicator affecting prices. September revealed two time-periods of great indecision. The series of Doji and Hammer formations were signals that investor sentiment was not able to push the price away from the moving average.

The gap up at the 50-day moving average becomes a signal that strong buying is coming into the trend, as discussed in the chapter on GAPS. As seen in the early part of January, the moving average once again acts as a support level, as indicated by the Doji followed by the Bullish Engulfing signal. Price moves occurring at these major moving averages is not happenstance. Many technical traders watch for these indicators. They are waiting to see what happens at these levels. The advantage provided to the candlestick investor is being able to visually witness what is happening at these levels immediately. Other techni­cal investors may require a few trading days of confirmation before they com­mit funds.