The brutal truth behind support lines …

A core fundamental concept of technical analysis is the study of support and resistance levels. This is the basis of every technical pattern, and major concepts like trend trading, candlesticks, and even Fibonacci retracements levels.
So what is a support level? Or a resistance level? Take a look at any stock graph – notice how a bullish stock moves in a period of time: it goes up, pulls back, and goes up some more … essentially creating a staircase. For example, take a look at my horrendous drawing below:

Notice, how the orange line bounces up, pulls back, goes up, and pulls back. I have drawn green lines to illustrate how it is creates something that looks like a staircase moving upwards. Now notice that huge red X : this is where the stock FAILS a green line step, and starts heading downwards … take a look at how the orange line starts taking a new staircase – in the DOWNWARDS direction.

In more technical terms, the green lines are SUPPORT LEVELS – as long as the stock continues making higher lows (i.e. the green lines continue to go upwards) and higher highs, we would consider this stock to be bullish. A stock is considered to be SIDEWAYS trending once it fails to make new highs (but doesn’t break the support level). And, once it FAILS a green line (along with starting to make lower highs), we now would have a new bearish cycle.

Once the green line (or support level) has been violated, it now becomes a RESISTANCE level – a level which the stock would have some difficulty breaking through (think of it like banging your head against a ceiling – you may reach it, but it would be very hard breaking through). Personally, I would be very cautious to take on any bullish positions one a support level has been broken. I would have to look to oscillators, moving averages, candlestick patterns etc, as for clues to tell me if this correction is temporary or a beginning of something more dramatic.

Is this practical? Of course it is. I didn’t just come up with this orange line – I actually took it from the stock graph of the SPY (the ETF that tracks the S&P 500 index):

We can see that once the stock fails the support level (marked by the huge red X); it begins to trend downwards, creating lower lows, and lower highs – the classic definition of a bear cycle.

Is this the beginning of a new bearish correction in the market?

This current break of support is way too early to generate such a conclusion. The chart above is a DAILY chart on the SPY which only illustrates the 3 month action of the SPY. Personally, I would look at yearly graphs, on a weekly timeframe to really get a feel of the major trend. All I know for certain is that right now, the index ETF has broken some short term support levels, so this tells me to exit any short term bullish trades until the stock stabilizes, and begins a new bullish cycle.

Thankyou,
Kunal