Price history tells us when securities are overbought or oversold

Overbought condition means the price point when buyers will be replaced by sellers for a position in that stock. An oversold condition means the price point when sellers will be replaced by more buyers who are bargain hunting or bottom fishing for profit opportunities. In economics, they call it the battle between "supply vs. demand." It stands up to reasoning.

By carefully reviewing any stock chart profile you can better estimate those price support and price resistance levels to help you handle your trading decisions and to exploit those profit opportunities. Regardless, if you are writing covered calls, buying and trading options, stripping dividends, or even writing LEAPs, you can apply this professionally used information to your advantage.

Now, let's take a closer look at exactly what happens in the real world and how the outcomes translate to price plots or points on a stock chart.

Support (bottom price support) indicates a price level on a stock chart profile where we can expect an increase in the demand for a security (the weak sellers fold and the buyers take over). How do we know this? By identifying this previous documented reaction to a price level in the chart's history. You see, if we astutely look at most charts, we see that for any stock there are certain price levels where the selling pressure subsides (slows down) and the price trend shifts and reverses as stock price increases. When this happens, we can assume that this price level will retain its significance when in the future the price approaches that level again.

I should stress that all recorded plots at the end of the day represent investor's or institutional capital buying and selling net results. It is as factual as your chest x-ray.A bottom price point is known as the price support level, because the securities price is supported at this level and the stock recovers. Conversely, the overhead price resistance is the level where the securities price has shown an inability to rise anymore, and a reversal to the downside can be expected. The RSI technical indicator is the perfect tool to review for that price level.

ABOUT THE AUTHOR: Larry Potter is a recognized authority on the subject of trading and has been publishing his newsletter, Stocks2Watch®, since January of 1998. Each evening, his newsletter contains picks for the next day and always includes a free trading tip.

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