Related to considering exit points and having mental, if not actual, stop losses to protect profits and limit losses, the disciplined short-term trader is often more tuned in than the long-term investor to what are called the support and resistance levels of a stock.

Support means the level at which a falling stock’s price will be met with buyers coming in to prop it up so that it does not fall further. The stock is deemed at the support price to be a good buy. Buyers are willing to jump in at this level. When you look at a chart of a stock, you can determine the level of support by noticing where it “bounces” off a price repeatedly.

There is usually more than one level of support, each signaling a more severe drop than the one above it. Stock charts indicate these support levels and are well worth paying attention to. If the long-term investor knows where the stock is supported, he or she may then use this information in considering entrance and exit points. When the stock breaks through its first support level, traders may use this information to consider getting out. They can see where the next support level will be. Often, breaking through the initial support means the stock will enter a free-fall before hitting the second level.

Not being aware of these fairly stable levels of support, long-term investors will tend to panic when the stock falls through the initial support level. They will then sell out of anxiety and even panic, having no idea why the stock is in a free-fall. The investor who is technically able to read the chart and determine these levels will not be surprised that a free-fall ensues when the stock breaks through its initial support level.

Long-term investors need to have this rudimentary information in helping them understand why a stock is falling so fast. Then they need not panic and end up selling at the bottom, which is often the second or third level of support.

Conversely, the concept of resistance is simply that a stock will tend to rise to a certain point and then have trouble breaking through a specific number. Some stocks will sit at their resistance point for days or even weeks or months before they break out and head higher. And sometimes they never will make it past a certain point, no matter how long you wait. You can watch it come right up to the number and then fall back; this will happen repeatedly, and when it does, it is viewed as the resistance point.

This, too, can be useful information for deciding a possible exit point. At the least, you have an idea why the stock refuses to go any higher when it hits this point. Although for those who do technical analysis the concepts of support and resistance are taken as a truism, large numbers of online investors do not know of them.

Sometimes these resistance points are whole numbers that mark a new decade, like 20,30, or 40. This is why you see smart traders put in sell orders for something like 29 7/8 rather than 30. They know it is tougher to push the stock to the next whole number and they also know that less sophisticated investors are thinking in terms of whole and half numbers. Because there are more of them waiting in line to sell at this round price, let’s say 30, they know it will be easier to hit the bid price of 29 7/8 or 2913/16 than the round number. So, basically, you decide to cut in line in front of everyone waiting for 30.

You can easily verify this by watching the movement of a stock on Level I dynamic, updating quotes. Sometimes the price will hang around the whole number a long time, just under it, before breaking through. I have seen times when the price never has enough steam to break through. This can be viewed as a “miniresistance” and is often controlled, at least to some extent, by market makers.

Of course, when the pressure of buy orders pushes the stock up, the market makers step out of the way and let it run its course.

A stock’s resistance point is important to know for another reason. When you see a stock break out sharply above the resistance point, you don’t want to be in a hurry to sell it, as it needs to be given some latitude to find the new resistance. When you watch quotes on a real-time “tick” graph that charts the movement from minute to minute, it is pretty clear after a while how these support and resistance numbers affect traders.

So, our main point here is that the concepts of support and resistance may be useful to longer-term investors, just as they are used by active traders, to help plot entrance and exit points, and to have a way to help make sense of a stock’s movement.

Now, like anything else in the securities markets, the concepts of support and resistance will hold for much¡ªbut not all¡ªof the action that takes place. There are limitations to all the charting concepts used by technicians, just as there are obvious limitations to the traditional fundamentals when applied to Internet companies.

No one¡ªwhether they were using technical or fundamental analysis, computer programs, phases of the moon (some were saying that the fact that the moon was 100,000 miles closer to the Earth on December 23,1999, closer than it had been in 120 years, made for the surge) or anything else¡ªcould have predicted an astonishing 86 percent gain in the NASDAQ for the year of 1999. The normal valuations applied to Internet and selected high-technology stocks went out the window.

Typical resistance points were blown through as if they never existed. The market showed us something toward the end of 1999 that no one had quite seen before. It left long-time Wall Street watchers and seasoned traders shaking their heads in disbelief.

Which all goes to prove what? That the market has a mind of its own. And sometimes it belies and perplexes even the most sophisticated computer programs that we can apply to it.

In Gestalt psychology, this is stated as the concept that “the whole is greater than the sum of its parts.” As applied to the market, we can take this to mean that no one individual can possibly grasp all the pieces of the market puzzle at once. As we said, we are always being forced to make decisions on limited data. No one person or group can control the whole market (on second thought, maybe Alan Greenspan can). But the forces of individual traders, fund managers, large institutions with computer programs, foreign investors, short sellers, options investors¡ªand every other human and material aspect of the market, through their respective complementary and opposing actions, together create an entity that is larger than the sum of all the individual parts.

All patterns that are used to predict future movement of a particular stock or the market as a whole are based on the notion that the past accurately predicts the future and that we can project these past patterns to predict the future. While this is more true in certain aspects of life, it just isn’t true when it comes to the stock market. While the past patterns may be quite useful in making educated guesses about the future, there is no direct cause-and-effect relationship, much to the dismay of business school professors, economists, market historians, chart technicians, and analysts.

It is far easier to predict the individual behavior of people playing the market than it is to predict the short-term or long-term moves of the entire market itself. You know the stale qualifier that all brokerage companies include when they give the yearly return on investment of funds: “Past performance is no guarantee of future results.” And, of course, sometimes past performance is a contraindicator of future results!

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