Describe a price trend and its support and resistance levels without treating them as forecasts.
Open a five-year price chart of any share you follow and circle every point where the price stopped falling and turned up, and every point where it stopped rising and turned down. You need those turning points to read trend, support and resistance, the most basic tools of chart reading. Used carefully, they describe where buying and selling happened in the past. Used carelessly, they become forecasts the evidence doesn't support.
Marcus, an investor following this course, opens a five-year chart of Larkspur, a made-up company (all prices here are made up too). He notices something he had never looked for. Over the past two years, the price stopped and turned up each time it fell to around S$1.50, and stalled each time it rose towards S$1.80. His first thought is that he has found a pattern to trade. His second thought, after module 9, is to ask what the pattern actually describes and whether it says anything about next month.
An uptrend is a sequence of higher highs and higher lows. A downtrend is a sequence of lower highs and lower lows. Both are descriptions, and you can check either on any chart by circling the turning points.
To check, list the lows in the order they happened and note whether each is higher or lower than the one before. Then do the same with the highs. Higher highs and higher lows mean an uptrend. Lower highs and lower lows mean a downtrend.
Larkspur fell to a low of S$1.30 during the FY4 downturn. It recovered to S$1.95, fell back to S$1.48, rose to S$1.78, fell to S$1.52, and now sits at S$1.60. The lows run S$1.30, S$1.48, S$1.52, each higher than the last. The highs run S$1.95, then S$1.78, which is lower than the first.
Rising lows with falling highs are not a trend in either direction. They describe a narrowing range: buyers step in a little higher each time and sellers a little lower. Calling it a narrowing range is more precise than saying the shares have gone sideways. A narrowing range is also no forecast. It ends with a move one way or the other, and the chart doesn't say which.
Support is a price area where buying has shown up before, strong enough to stop a fall. Resistance is a price area where selling has shown up before, strong enough to stop a rise. Mark both as ranges rather than single prices, because traders don't all place orders at the same cent. Marcus marks support at S$1.45 to S$1.52 and resistance at S$1.75 to S$1.80.
Orders bunch in these areas for three reasons. Investors who missed buying at a level last time leave limit orders there in case the price returns. Investors who bought near a higher level, such as buyers near S$1.80, watched the price fall and want to sell once they can get their money back. This is the reference-point effect from Behavioural Finance: why you make the money mistakes you make, lesson 2.1, "Gains and losses are judged from a reference point". Round numbers such as S$1.50 also attract orders of their own.
Lesson 5.1, "Exchanges, market makers and how your order gets filled", showed that the order book is a list of choices people have made. Support and resistance are where those choices bunched together in the past.
Before giving a level any weight, test it. Count each time the price reached the area and record whether it turned back or broke through. Total the holds against the visits, judge whether the sample is large enough to mean anything, and check whether the breaks lined up with changes in the business news or fundamentals.
Over five years, Larkspur visited support 4 times. It turned up 3 times and broke through once, during the FY4 downturn, when it fell to S$1.30. It visited resistance 3 times, turning down 2 times and breaking through once, on the way to S$1.95 before it fell back. Together, the levels held 5 times out of 7.
A high hold rate like that can be produced by chance. Prices that wander up and down often reverse near recent turning points, partly because that's how those turning points were drawn. Seven visits is far too small a sample to separate a real tendency from luck.
Look at the breaks as well. Larkspur's levels broke when the business news changed: a downturn, then a recovery in orders. The levels gave way when the fundamentals moved. The orders that formed a level last year may also not be there next time. Buyers may have bought, given up or changed their minds, and sellers may already have sold. A level is a record of where orders sat, and order books change every day.
Chart levels should not decide whether you buy or sell. A stock at support isn't cheap because of where it sits on a chart, and a stock at resistance isn't expensive for that reason. A stock is worth whatever its cash flows are worth, and the chart has no view on that. Whether Larkspur at S$1.50 is worth buying depends on its cash flows. Module 8 estimated Larkspur's value at S$1.58 to S$2.08 in the central range, and that work, together with modules 9 and 11, is what a decision should rest on.
Levels have a modest role only after you've made the decision on fundamentals. If you're adding to a holding, a recent support area is a sensible place to rest a buy limit order. Sellers have accepted prices there before, so the order has a fair chance of filling without paying up. A resistance area is a place where a buy limit is less likely to be needed, because sellers have tended to appear there.
The cost of using levels this way is that the order may never fill. If Larkspur never returns to S$1.52, a limit at S$1.52 buys nothing. For an investor adding to a long-term holding, that trade-off is acceptable. Lesson 10.7, "Use a chart to time entry within a decision made on fundamentals", builds limit orders at support into a written entry plan.
Choose one holding with at least five years of price history, open its chart, and get ready to mark the turning points, the trend if there is one, and the two price areas where it has most often reversed.
On a five-year chart of one holding, mark the trend and two support or resistance areas, then note how often price respected them.
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