How to use support/resistance levels to time your trades

Today while surfing the market, I tripped over the chart of Jones Soda (JSDA).

Jones Soda…hmm….hadn’t that been one of Jim Cramer’s darlings a couple of years ago? Looking back at his predictions (culled from the Lightning Round blogs on, Jim felt that the stock was undervalued in December of 2006 and initiated a long position near $11. He stopped adding to his position just after the stock began its precipitous fall from its $35 high in April of 2007, but he didn’t publicly pull the plug on the trade until November 5th when it was trading just under $9, about $2 short of  his initial purchase price.

Despite the fact that Jim claims he knows how market technicals work, if he had understood the first thing about support and resistance levels, he would have known when to initiate his long position, when to add to it, and when to begin unwinding it. And if Jim was a shorting man, he could have eventually made a boatload on the down side, too.

The chart of Jones Soda clearly illustrates how to use support and resistance levels to your trading advantage.

Let’s a take a look at the company’s daily chart around the time of its all time price high in April of 2007. Key trading dates are identified by numbers; the lines represent support/resistance.  Click on image to enlarge.

Jones Soda Chart 12-22-09

Trading strategy
Below is a summary of how one might use support/resistance levels to enter and exit both long and short positions on Jones Soda. Entry and exit points are identified by the numbers in the above chart. Please note that all prices mentioned in the following discussion reflect end of day quotes.

#1 (12/22/06): Cramer touted this stock in his CNBC “Mad Money” show the day before causing the stock to break out of an eight month base. Although it’s sometimes difficult to know if a stock move is “real” versus a potentially short-lived phenomenon created by the so-called Cramer Effect, the 13% jump on much higher than average volume is a good indication that the move contains more of the former element rather than the latter one.
Action: Buy partial position at $12.11/share.

#2 (3/9/07): The company handily beats earnings estimates and pops up 19% on the open.
Action: Add to position at $17.13.
Price difference from previous point: +$5.02 (41% gain)

#3 (4/26/07): Following the its all-time high of $35.60 on 4/16, the stock retreats. Note the massive volume accompanying this high along with the topping tail on the candlestick. The next day, the stock tumbles, also on high volume. All of these are early warnings that investors are beginning to sell. The stock then tests the $25 level before it pierces it on 4/26.
Action: Short-term traders should begin taking profits at $24.11. (Note that this is the day where the 20-period CCI (commodity channel indicator) crosses into negative territory.) Longer-term traders may wish to wait for further downward confirmation.
Price difference from previous point: +$6.97 (41% gain)

#4 (5/10/07): Technically, the stock broke this resistance level on 5/4 after it missed earnings but rebounded briefly before breaking this level decisively, closing at $21.55.
Action: Short-term traders should exit most of their positions; longer-term traders should begin unwinding their holdings.
Price difference from previous point: -$2.56 (11% loss)

#5 (5/29/07): The $20 major support level is broken on higher than normal volume. Note that the longer period 50-day CCI is now solidly in bearish territory.
Action: All long positions should be exited at this point and a short position can be initiated at $19.38.
Price difference from previous point: -$2.17 (10% loss)

#6 (6/12/07): Support is again broken.
Action: Short sellers can add to their positions at $16.37.
Price difference from previous point: -$3.01 (15% loss)

#7 (8/3/07): The company misses earnings for the second quarter in a row. Note the huge spike in volume.
Action: Short sellers can add to their position at $11.35.
Price difference from previous point: -$5.02 (31% loss)

(Not on the chart) The Stock reaches its low (1/2/09): From here, the stock breaks another key support level at $10 for the first time on 9/6/07. It recovers briefly before breaking it again on 10/29/07. From here on out, the stock continues declining, taking more than 14 months before it finally finds its bottom on 1/2/09 at 30 cents, down 99% from its peak value!
Action: Had you been lucky enough to hold onto your short position for this long and cover it, you would have realized a gain of $11.05 from point #7 for a gain of 97%.

Strategy comparison
Jim jumped into this trade on 12/21/06 and didn’t unload his position (at least not publicly) until 11/5/07. Assuming these entry and exit points, here’s how his fundamentally-based strategy performed versus ours based purely on support and resistance levels. In our strategy, I’ll be taking only full positions at entry and exit points to simplify the calculations.

Cramer’s Strategy
Buy price (12/21/06): $10.65
Sell price (11/4/07): $ 8.85
Profit/loss -$1.80 (17% loss)

Our long strategy (based on Entry points #1& #2):
Buy full position either at:
#1: Buy price (12/22/06): $12.11
#2: Buy price (3/9/07): $17.13

Sell at Point #3 (4/26/07) at $24.11
Entry #1 Profit: $12.00, 99% gain
Entry #2 Profit: $6.98, 41% gain

Sell at Point #4 (5/10/07) at $21.55
Entry #1 Profit: $9.44, 78% gain
Entry #2 Profit: $4.42, 62% gain

Sell at Point #5 (5/29/07) at $19.38
Entry #1 Profit: $7.27, 60% gain
Entry #2 Profit: $2.25, 13% gain

You can see that even if we had missed some of the earlier entry and exit points, we still would have made money. I won’t go into calculating profits on the short side but you can see that a short-seller would have had a field day with this stock, possibly netting up to $20/share.

My goal for today’s blog was not to rag on Jim Cramer (although it is fun to do on occasion), but to show you how to use support and resistance levels as an entry and exit strategy. In the interest of full disclosure, not every chart has such clearly defined support/resistance levels, but with practice you’ll soon be able to identify even the less obvious areas of price consolidation and be able to incorporate them into your own trading schemes. Happy trading!

Addendum: What prompted me to write about Jones Soda was the action in today’s chart: a huge bottoming tail accompanied by explosive volume, typically a sign of major short-covering. According to today’s news, I see that the company is being courted as a possible take-over candidate. Although the current deal is for about half of the company’s market value, it is a positive sign that someone is interested in the business model.

If this is the case, the stock could soon rocket in the other direction. You risk-takers out there might consider tossing a few schekels at this trade if it rebounds tomorrow. Considering that the price per share is less than the price of one of their sodas, this could be one trade that’s easy to swallow!

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