Psychology of support and resistance

The psychology of support and resistance

According to the technical analysis, the price of a stock will evolve within a channel. The walls of this channel are called the support- and resistance- lines (see figure). Today, the economical journalists often consider support- resistance-, and break-troughs. Technical analysis seems therefore to be, not only well spread, but also, generally accepted.

Everything may happen

When the price approaches a support- or resistance- line, it will, according to the technical analysis, either bounce back, or, -believe it or not- break through the line. The analysis does not tell which event is most likely!

Confirmed lines

If the bar chart has touched, or almost touched, a support- or resistance- line several times, then the line is considered to be more reliable. According to the pseudo theory, the market has confirmed the support- or resistance- line.

Experiment

Please, do the following experiment: Click to produce a few random bar charts, and examine if they usually touch the walls of the channel! Question: Has the powerful market-force penetrated our random number generator?

Mass behavior

According to the pseudo theory, the channel has been created by mass behavior. It is the history of past and present shareholders that has created pressures to buy and sell the share at certain price levels. Therefore, by carefully studying the bar chart one can predict the future.

Believers in this hocus-pocus also draw channels around index prices such as Nasdaq. But why should the index follow a channel? Does anyone believe that a share holder would sell a certain share only because the average of all shares on Nasdaq has reached a certain level?

Unnecessary hypothesis

Since we can draw a channel around random walks the mass psychology theory is unnecessary. There must be another explanation for the channels. Our explanation is seen below.

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Explaining the illusion

How to draw a channel

The support line should be drawn below the chart and the resistance above. Furthermore, the lines should be placed to make the surface in between them as small as possible. That is to say, to make the channel as narrow as possible.

The result is always impressive.

The price never breaks though the walls of the channel.
The bar chart will touch each wall at least two times (sometimes several times)!
The course seems to oscillate between the walls of a narrow channel!

Hence, we have the illusion that the walls are barriers. But it is you who have drawn a narrow channel around an existing curse!