When a trader is buying a stock they are doing so in the expectation that it will be more valuable at the end of their holding period, whether the holding period is 5 minutes, 5 days, or 5 years. The very nature of good trading demands a target be set so how much more it will be worth if it reaches expectations will be known. While trading can be part “science” and part “art” setting a target will still imply some sort of measurement.
This is true of setting stops as well. The size of any loss in any stock position must be known before taking the trade. (Think about this: Wouldn’t that be great to know how much you could lose in advance of buying a stock?) It is sad that this is lost on most traders and investors and they have no firm idea were they will sell a stock after buying it.
Successful traders always take notice of where support and resistance areas are on a chart they are trading to help them determine where to set a target and a stop. Resistance being the area that they expect selling to pick up near or at least price to stall out; and support being the area that they expect buying to pick up near and price mayl bounce.
Why is this important to know? A smart trader buying a stock will take note of the distance from their entry point to the resistance area so that they can determine a possible profit (target). They will also measure the distance to the support area below their entry to determine a possible loss (stop), if things to do not go as expected.
Smart traders will also make sure the distance to resistance (target), is more than the distance to support (stop); so that a good risk reward is a feature of the trade. But how do we determine how strong support or resistance will be?
This is where the “art” part of trading comes in. While there is continual occurrence of trading patterns and repetition in human psychology to dismiss technical analysis, it is not a science. Approaching trading from a purely scientific point of view will usually lead to disappointment.
Trying to determine if resistance will be strong enough to hold, and therefore could be used as a target to sell all or part of a position is the “art”. This is a bit like trying to determine if a truck traveling down a road will be stopped if it hits something. We are trying to determine if that something the truck hits will be like a concrete wall or a wall of empty cardboard boxes. If the truck hits a wall of concrete then forward progress is probably stopped in its tracks and it may bounce back off. It is hits a wall of empty cardboard boxes it probably slows down very little, if at all, and plows right through.
So there in lies the craft of figuring out what a stock may do when it hits a support or resistance area.
There are many indicators that traders use to help them determine where these areas are such as Fibonacci lines, moving averages, trend lines, and prior consolidations. But whatever method or methods a trader uses to determine where the areas are they will still need to determine how strong they may be.
Trade with a plan.