A look at TSLA since November clearly illustrates an important dynamic that occurs in markets with regards to support and résistance levels. Experienced traders know that levels that were support in the past can become resistance levels in the future, and conversely levels that were resistance in the past may become support levels in the future.
If you think deeply about this, it is really an astonishing phenomenon. For example, take a look at this chart of TSLA since last November. Back then it found support right at the $310 level. Then it found support again at this precise level in February and again for four days in March before the big selloff. Then in April it hit resistance right there again and again earlier this month.
Ask your friends who are academics or 'random walkers' or fundamental investors who don't believe in 'technicals' to explain how this can happen. Based on the fundamentals how can this stock have the exact same valuation at these five different distinct times? Interest rates have gone up, the price of oil has gone up, earnings estimates have changed, there are tensions in Korea and the Middle-East, etc... and yet some how the company had the same valuation. Don't hold your breath waiting for an answer though, because they aren't going to be able to give you one.
Experienced traders know that this dynamic occurs because markets do in fact have 'memories' and there are levels that are more important than others. I'll explain why this occurs but first take a look at this chart of Tesla (TSLA) since November and you can see what I mean.
What are Support and Resistance Levels and Why do they Exist?
Support is a concentration of demand and resistance is a concentration of supply which are sufficient to stop and possibly reverse a trend. These are historical levels where a large number of shares traded in the past.
There are three different types of players active in the market. Those who are long, those who are short, and those who are do not have positions but are watching and waiting for an opportunity.
So, say a stock trades a considerable amount of volume right at the $20 for one month. This is how a sideways market is traditionally explained. As viewed on a chart this would be a perfectly horizontal line which extends for a month. In the real-world stocks never stay at such a precise level for so long but this is just a hypothetical example.
Then suppose the stock goes to $21. Those who bought the stock are happy that they are correct but they are angry they didn’t buy more. They say to themselves that if it comes back to $20 they will buy more. Conversely those who shorted it at $20 are angry that they are in a losing position and say to themselves that if the stock comes back to $20 they will cover their positions and break even. The third group is those who are watching. These could be traders who saw that the stock spent a lot of time at the $20 level, so when it moves away they are watching to see if it sells off. They buy it when it comes back to $20 because they think that the other buyers we discussed will be there as well. If there are other buyers, the traders consider this a low risk buy…meaning that if they change their minds and don’t think they are right they can turn around and sell it to one of them at $20 so they won’t lose any money.
So now we see why $20 will become a support level. It is because there is a large vested buy interest or demand for the stock at that price. Because this example is of a neutral or sideways market, meaning that the forces of supply and demand are roughly equal, the sellers will eventually push it back down from $21 to $20. If it was a Bull market those who were at $20 wouldn’t mind paying a slightly higher price and this is what causes Bullish Markets or Uptrends. More on that later.
When you understand these dynamics, it is easy to understand how levels that were support become resistance, and levels that were resistance become support. Suppose that our hypothetical stock trades below $20 and drops to $19. This would happen if the market went from neutral to a more Bearish Stance. More people were willing to sell at $20 than there were to buy. And because they are now bearish, some sellers are willing to accept prices below $20 because they believe that markets will continue to go lower.
So now the dynamics have reversed. Those who bought at $20 and were happy that it went to $21, are now upset and mad at themselves for not selling it and taking their profit. Now they have a loss, but they vow to themselves that if it rallies and gets back to $20, they will sell it so they can get out at breakeven. And those who shorted it at $20 are happy and say to themselves that if it gets back to $20 then will short more. So now we have a large amount of supply and sell interest at the $20 level.
Speaking of Tesla, this article caught my eye this morning....
Tesla CEO Elon Musk Is Cracking Under Immense Stress and Investors Should Worry
The stress of trying to build the future of transportation may be increasingly weighing on Tesla CEO Elon Musk. Meanwhile, don't get tricked into thinking calm has returned to this market as it could prove fleeting.
Elon, what are you doing?
The feeling here in San Francisco, the tech capital of the U.S., on Tesla (TSLA) CEO Elon Musk is that he has kind of gone off the deep end. That's the sense I've gotten from talking to folks the past few days while in town -- note these are people very plugged into the tech scene and what's happening in Silicon Valley. I can't say I disagree with them -- it's clear that Musk is under immense stress and it may be taking a toll. The fact this burnout is playing out on social media is a tremendous risk to Tesla shareholders who have to deal with headline risk from Musk and fundamental issues at the electric carmaker.
In his latest Twitter tirade, Musk attacked journalists who apparently are nothing more than click-driven machines. Said machines will create salacious fake news to get bonuses and if their stories aren't read editors simply cut them loose. Musk then promised to create a website that tracks the authenticity of the reporting done by reporters. My response to Musk on Twitter: "My man, what are you talking about? That's not journalism." I eagerly await Elon's reply.
Some data suggested he will reply very soon. According to the Tesla experts on Twitter @Teslacharts, Musk is now up to tweeting eight times a day, on average. That's up markedly from the mid-four range Musk averaged for most of 2017. With the increasing number of tweets this month, Musk's favorite stock -- Tesla -- has gone the other way. Shares are down 1.6% month to date, trailing the Dow Jones Industrial Average's 3.6% gain. Elon, stop tweeting and focus on attracting more executives. The fact Tesla only has two members to its executive management team besides Musk is troubling.