A support level is a price point on a chart that an asset, like a stock, has difficulty falling below over a period of time. Think of it as a floor or a safety net that temporarily halts a price decline. This “floor” is created by a concentration of demand or buying interest. When a stock's price drops to a support level, the number of investors willing to buy the stock outweighs the number of investors trying to sell it. This surge in buying power pushes the price back up, at least for a while. Support levels are a core concept in technical analysis, a discipline that uses historical price charts and trading volumes to forecast future price movements. While some purists in value investing might scoff at chart-gazing, understanding support levels can offer valuable insights into market psychology and help identify potentially attractive entry points for a fundamentally sound company.
Support levels aren't magical lines drawn in the sand; they are born from human psychology and collective market memory. Imagine a stock that previously hit a low of $50 before rebounding sharply.
This confluence of buying interest forms a psychological floor. The more times a stock touches a certain price level and bounces back up, the more established and significant that support level becomes in the minds of traders and investors.
Spotting potential support levels is more of an art than a science, but there are a few common methods investors use by looking at a price chart.
The simplest method is to look for historical price troughs. If a stock's price has fallen to a specific level multiple times in the past and then reversed course, that level is a strong candidate for a support zone. You can often draw a horizontal line connecting these lows on a chart to visualize the support area.
Certain moving averages—like the 50-day, 100-day, or 200-day moving averages—can act as dynamic support. Instead of being a fixed price, this support level moves along with the average price over time. In a long-term uptrend, it's common to see a stock's price dip down to its 200-day moving average and then bounce off it as buyers step in.
In a rising market, a stock will make a series of “higher highs” and “higher lows.” By drawing an upward-sloping line that connects at least two of these “higher lows,” you can identify an upward trendline. This trendline can often act as a diagonal support level for the duration of the uptrend.
So, does any of this chart-watching matter to a value investor focused on a company's intrinsic value and business fundamentals? The answer is a resounding: it can. While a stock's true value comes from its underlying business, support levels can be a useful tool for execution.
A value investor's primary job is to determine what a business is worth and then wait for the market to offer it at a significant discount—the famous margin of safety. Support levels can help with the “when to buy” question. For example, let's say your analysis shows a company is worth $150 per share. The stock is currently trading at $110, but you notice a very strong, historically tested support level at $100. Knowing this, you could set a limit order to buy shares at or near $100. This way, you combine your fundamental thesis with an understanding of market mechanics to potentially get an even better price.
A decisive break below a major support level is a significant event. It often means the seller-buyer dynamic has shifted, and the price could fall further until it finds a new, lower level of support. For the value investor, this should trigger a question: Why did it break?
Before you start drawing lines all over your charts, remember that support levels are not unbreakable laws of physics. They are simply areas of high probability.
Ultimately, for a value investor, technical concepts like support levels should be a secondary tool. Your primary focus should always remain on the quality of the business and the price you pay for it.