Previous Support becomes new Resistance once broken

 

 

 

A very important technical analysis rule is that once support is broken, it should act as resistance. Conversely, once resistance is broken, it should act as support.

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This rule stems from pure human psychology. Consider the chart of ACC below. Most investors are well aware that the 50sma and the 200sma act as strong support/resistance areas. So what happens when ACC approaches the 50sma from above? Traders start buying the stock. The bulls cannot rally it the first time, and the stock tests the moving average again. The bulls who missed the rally the first time, start buying this time around. After rallying for some time, now ACC comes back to test the 50sma. Those traders who missed the first two times to get in the stock, now start going long. However this time the bears are more powerful and the stock crashes through support. Keep in mind that the new traders are now facing a loss and want to get their capital back. They are no longer interested in making profits. They are also aware that it is going to be difficult for the stock to cross the 50sma to the upside. So what happens as the stock approaches the 50sma from the downside? These traders now start selling their positions to get the best possible price. At the same time, shorts are piling in the stock because they know the 50sma will act as resistance. psychology feeds on itself.

Always keep this support and resistance rule in mind when trading technically.

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