A resistance point marks the spot where most traders think it's high time to sell their stock. It is usually the recent high, but it can be at any point where the stock began a big drop. Buying in at a support point because you have a hunch that support will hold is an easy decision. Knowing when to sell is more difficult. There are three types of sellers at a resistance point. This is where greed lurks and can lure you into trouble.
The first type of seller is the guy who bought a stock around its previous high and has nervously watched the price slip down to the support point. When the stock trades back up and approaches its original purchase price, this seller is all too glad to dump it and recover his money. This is what you want to avoid. It's a good reason to sell your stock as it approaches resistance.
Some traders will follow a stock long enough to learn its support and resistance points. They set their orders to buy at support and sell at resistance, often well in advance of the market move. This is a good way to trade. If the stock price trades up through resistance, buy back in for a ride up to the new high, but wait to see if the breakout is backed by continued buying interest. The resistance point just broken is the new support point in the next trading range.
Playing it Short
The third type of seller also watches support and resistance, but this seller is betting the stock will hit resistance and trade back down to support. These traders are short-sellers who sell the stock without owning it and hope to cover the sale at a lower price. Short-seller strategy involves creating enough selling pressure so weak-kneed traders get scared and sell their positions. That will add more selling pressure and drive the stock price down fast. This kind of market generally comes with no warning -- just a huge sell order hitting the market all at once.
A stock approaching resistance might have enough upside momentum to trade up through that resistance point. It will then trade significantly higher to establish a new high price. Traders love to play these breakouts, but it comes with a risk. If the stock doesn't break out, it will drop fast and you'll lose money. Hold on to your stock only if the company has posted great news, there has been unusually strong buying volume, and the stock has tested resistance at least twice.
Trading the Bounce
Selling your position as it approaches resistance is a safe thing to do. Taking profits is never wrong. Plus, you can always buy back in if the stock confirms a breakout above resistance. Even if technicals show the likelihood of a breakout, it may not materialize. If it doesn't, and you keep your stock, you are stuck where you don't want to be. So, if the stock doesn't breakout, the best choice is to sell out and hope to buy back in at support.
If you're worried about whether you should sell your stock at resistance, you are a trader. Investors buy for the long term generally because they like the company's potential. Traders buy for short-swing profits and generally focus on technical analysis. Neither form of analysis is fool-proof, so taking profits when you have them is always a good thing to do. If you're using an online broker, the cost of your transactions are low enough you can always buy back in if you think you sold too soon.
Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.