J Welles Wilder is an important market analyst. He developed popular indicators including RSI, ADX, and several others. (As an aside, those indicators don’t work like Wilder said they did, but they can be useful when tweaked. But that’s a story for another day.)

To me, Wilder’s most important contribution was his insight that prices only trend about a third of the time. The rest of the time, prices fall into a trading range defined by areas of supply and demand.

Trends: Resistance vs. Support

A chart is probably the best way to start defining this concept.

To me, the blue rectangle defines the trading range. Resistance is at the top of the range and support is at the bottom. The initial breakout is followed by a throwback and a subsequent rally.

Each of these terms can be defined.

Resistance is a level where sellers are expected to enter the market and the selling pressure should be enough to temporarily stop the advance. Resistance is a “ceiling on the price action.”

Support offers a “floor below the market” and is the value where traders are expected to begin buying.

The Psychology Behind Resistance And Support

These price levels are approximate, and they can be explained with investor psychology. In the next chart, I’ve added numbers where we can generalize the thoughts of most investors.

(1) “This stock is a bargain, and I am buying.”
(2) “I am an absolute genius. This stock will gain 1,000% in no time.”
(3) “This is a normal pullback.”
(4) “Here we go, this stock only goes up.”
(5) “Maybe I should sell if it gets back to those old highs. After all, I have a big gain and I’m still a genius.”
(6) “Oh, I see other people are selling. They’re taking profits. I was right, I am a genius. I’ll hold.”
(7) “Well, that was quick. I need to sell next time this stock rallies.”
(8) “I’ll sell as soon as this stock reaches a new high.”
(9) “Okay, really, I’m selling the next rally.”
(10) “I’m out now.”

After the original group of buyers who bought below the support level is out of their position, the stock is ready for a strong rally. And that rally will be followed by another trading range.

Why Resistance And Support Matter

This is roughly how the market works. Buyers and sellers are considering where they entered their positions and making decisions based on that information. It’s just human nature.

Trading ranges develop in any time frame, and they develop at various price levels. Looking at the market today, we can see a clear trendline at around the 2,800 level on the S&P 500…

As the market sold off in the wake of the coronavirus pandemic, this level was a key area of support. But as the pandemic spread (and market conditions worsened), prices fell through that level and became a key resistance level.

Watch this key level in the coming days and weeks. As the market tries to rebound, expect prices to bump up against this level. A clear breakthrough could be a sign that investors think the worst is behind us, setting up the stage for a throwback – and then a new rally.

I don’t expect we’ll see this happen anytime soon. But either way, traders will need to be ready. For example, my colleague Jim Fink uses a strategy that’s proven to work in up, down, or sideways markets.

By following just a few simple steps, this strategy allows you to take regular stock movements of 8%, 17%, or 34% and amplify them to generate profits of 100%, 300%, even 800%. As Jim recently told me, this might be the most important work of his career – so you don’t want to miss out. Go here to learn more.