“How do you decide when to buy or sell?” is a question I get often from investors and traders. After all, you can pick a great stock, but if your timing is wrong, you’ll lose money.
Early in my career, when I was first studying technical analysis – the use of market data and charts – I came across a simple but effective rule to make buy and sell decisions easier.
I use support and resistance levels to time my entries and exits.
Support is a level where a stock stops going down. It could be for a variety of reasons, but that price level shows over and over again that it acts as a floor for the stock.
You can see what I’m describing in this chart of GrowGeneration (Nasdaq: GRWG). Every time the stock dropped to about $37, it bounced. That $37 area serves as support. If you were looking to buy the stock, the support line (or close to it) would be a good place to get in because if the stock breaks support, that suggests something in the market has changed and you can cut your losses quickly, keeping them small. So buying near support lowers your risk.
And in fact, GrowGeneration’s stock did break beneath support on Thursday, as seen in the chart below.
When you see a stock break a strong level of support, that’s your sign to head for the exit. I generally want to see a drop of about 3% below the support to feel confident that the move is real and not market noise.
It’s not a guarantee that the stock is going lower, but it does suggest that the psychology of the market has changed. Buyers stopped stepping in to buy the stock at $37. We don’t always know why, but they stopped.
Support does not have to be a flat line at one price.
Look at this chart of Morgan Stanley (NYSE: MS). The blue line is called an up trend line. It’s a line of support that is rising. Every time the stock hits the trend line, it bounces. Again, as a stock approaches its trend line (support), it’s a good spot to enter a trade. If it breaks below the trend line by 3% or falls below the previous low, that’s a good spot to get out.
The opposite of support is resistance. That’s an area that a stock has difficulty getting above.
This chart of TE Connectivity (NYSE: TEL) shows the stock had problems rising above $140. If you were interested in the stock, it would have been a good idea to wait until it broke $140 to know that the psychology about the stock had changed and the sellers were no longer overpowering the buyers.
That happened in late July.
You can see that the stock meaningfully broke $140 and continued higher.
And just like support doesn’t have to be at one price, neither does resistance.
Here’s an up-to-date chart of Delta Air Lines (NYSE: DAL).
You can see that the stock has been moving lower, hitting resistance along a down trend line since June.
If you were interested in buying Delta, it would have been a good idea to wait until a meaningful break of that trend line (resistance). Or, when the stock approached the trend line, it would have been a good spot to short it.
You can see that the stock recently broke above the trend line by about 3%. Bulls may want to buy the stock here because if it slips back below the trend line, then you know it’s probably a false breakout and the sellers are back in control. You can cut your losses quickly.
As I always say, technical analysis is not crystal ball reading. But it provides strong guides for when you can consider entering and exiting trades based on changing psychology in the market.
Importantly, it gives you a plan for your buy and sell decisions that removes emotion from the process. If you know you’re selling a stock once it drops 3% below support, then you can pull the trigger on that sell order without rationalizing why you should stay in. The chart is telling you it’s time to get out.