The concept of resistance and support in charts can be confusing and frustrating.
Resistance is when a share just seems to be bumping its head against a price level or range - it seems stuck below a level and sellers seem to come into the market every time that price is reached.
FirstRand is a share that was troubled by strong resistance. In 1998, a huge share issue took place. There was a potential oversupply of FirstRand shares in the market, but no shortage of buyers at lower prices.
The price reached R13.25 that year, and then fell back but for the following five years it stuck around R9 on each upward rally. Guess at what price the 500-odd million shares were issued at in 1998? You got it ... R9.
Adding to the supply pressure then were sales of the share by Anglos and DeBeers.
Resistance in technical analysis refers to a price level where an un-usual amount of shares were absorbed by the market. After the euphoria fizzled out and the share price retreated, every time the share price returned to its original level, many shareholders breathed a sigh of relief.
Until the oversupply is digested, the share will struggle to get through the level where (now) disappointed shareholders bought into the share.
The tougher the resistance level, the more potent the move will be once the share price manages to breach it.
For the patient investor, pullbacks from the resistance level can be a great buying opportunity and breakouts from the resistance level can even yield good short-term gains.
FirstRand broke out of resistance in 2004, after the end of the selling programme by Anglos. The shareprice gained 50 per cent that year, compared to an annualised return of some five per cent for the previous five years.
My favourite technical analysis book, Technical Analysis Explained(Martin Pring, 1991 McGaw-Hill Inc), lists a few guidelines for assessing a resistance zone (also applicable to support zones):
- The more volume traded at the resistance level, the more significant the level. Look out for share issues; they signify an extra supply of shares and may not be reflected in the charts.
- The more dramatic the move up to the first time the share hits resistance, the more potent the resistance. The FirstRand share price moved too fast too soon, and only time and the shake-out of non-committal shareholders would remedy the situation. In 1997, the year preceding the large supply of FirstRand shares on to the market, the price had doubled.
- Finally, you need to look at how long the share has been stuck and what has happened to the market in that time. It took five years for Firstrand to break out, which made the subsequent move all the more powerful.
When a share frustrates you with a classic pattern of resistance, apply these three rules. Also assess the valuation and use the opportunity - don't run with the selling sheep when it comes to the late stages of strong resistance levels.