Last time, I told you how I sold my Microsoft (MSFT) shares at $23. Afterwards, it sank under the $23 mark and hovered there for a few days. Yesterday, it closed up at around $23.50 on a day that saw a lot of return to tech stocks. What’s in store for Mr. Softy?

Today will be a big test for the stock. If MSFT breaks $24 today and stays well above $23.50 on Friday, I think we may have seen the true bottom for this episode. On the other hand, there is still a possibility the stock will sell off after these gains and plummet to new lows (look around May 6th on the chart above). How’s that for ambiguous?

I’ll be honest here. In true InvestorGeeks style, I’ve been winging it this whole time with MSFT as I brought myself up to speed on “technical analysis” and how to read charts. Below I’ll go through my evolution as a chart reader and technical analysis convert, and show you the different chart tools and technical indicators I’ve been looking at lately as I follow MSFT and other stocks. I’ll cover support and resistance levels today and go into moving averages, stochastics, and moving average convergence divergence (MACD). (I know you’ve been waiting for these guys, but just wait a little longer. It’s good stuff coming.)

I’ve always been a fan of trying to predict a stocks movement from its chart. I even fancied that I had a natural ability to “read” a chart and predict the future. I would look at the graph, and it would just pop out at me like those magic eye pictures, making it obvious which way the stock was going. My research into technical analysis put a name on a few things that were familiar to me in my amateur chart reading, resulting in a reaction very similar to my first computer science courses at college: “Ahh. Ok, so that’s called recursion.”

Ahh. Ok, so that’s called a “support level”. Oh, yeah. And that’s a “resistance level”.

Look at the 2-year chart of Microsoft stock above. Notice how in January of 2006, the stock price dips down to $26 and then goes back up. Then it dips down to a little above $26 and goes back. And again. Imagine that the stock price is marked by a ball bouncing up and down on an invisible mountain. You can’t see the mountain, but you might conclude that there is some mass at the $26 level supporting the Microsoft ball. Notice too that there is a resistance level at about $28 from August 2005 to present. MSFT just can’t seem to break above the $28 level.

After some reading, I now have genuine (Wall Street gibberish) terminology to use for what used to be just intuition in my chart reading: support levels and resistance levels. These are relatively simple tools, but they can still be put to good use. The folks over at HipEgg are a good example of some guys who use this tools rigorously.

Now, why wasn’t MSFT breaking above $28 or falling below $26? The truth is we won’t really know. We’ll get a little closer as we get into more complicated technical analysis tools, but we’ll never ever truly know. The reason this kind of observation (this almost whimsical observation) holds up though is that it loosely reflects the sentiment of MSFT investors. Consider the following:

– There are a lot of people who bought MSFT stock at $28 per share only to watch it drop down to $26. If these guys hold onto their stock, and ride it back up to $28 per share, they’re going to be more than happy to sell the stock to break even on their investment.

– There are a lot of people who bough MSFT stock at $26 per share and have just watched it soar up to $28 per share. Last time this happened, the stock dropped back down again. These investors will be more than happy to take their $2 return and wait to see what happens.

There are a bunch more scenarios you could come up with to explain the support and resistance levels. Let’s just be aware that stocks have a tendency to fall into these types of patterns. Think of Newton 3rd Law: An object at rest will stay at rest unless acted upon by an outside force. Similarly…

A stock that is locked into a support/resistance cycle will bounce back and forth from support to resistance unless acted upon by an outside force.

In early May, MSFT needed a catalyst to push it above the $28 level. Instead they got a bomb, a catalyst of the wrong sort, and the share price sunk.

So what happens after a stock breaks through a support or resistance level? In general, a stock that breaks through a resistance level is going to run up. And a stock that breaks through a support level is going to run down… until acted upon by an outside force.
If they exist, a stock may fall back into old support and resistance levels. When MSFT dropped in early May, I expected it to still respect the older (April 2005 and October 2005) support levels at $24. It fell through those levels though, and at that point we were relying on the even older support levels which were setup at $23 back in 2002 (see the 5-year chart below).

Then we saw a dip below the $23 level, which spelled trouble. But we’re back up now. It’s a little too early to tell if that was a hiccup or not. Another dip below $23 will look really bad.

Where is the resistance level now? How high can MSFT go? Another characteristic of stocks that have broken through a support level is that oftentimes the old support level will become the new resistance level. The reverse is true as well: an old resistance level can become the new support level when broken. If that holds true for Microsoft, we could see new resistance when the stock goes back up to $26. Heck, it looks like we could be seeing resistance at the $24 level. Let’s see how MSFT does with that one over the next few days.

Resources:
– HipEgg: Stock analysis using support and resistance levels as well as some other chart reading techniques.
– Support and Resistance Basics at Investopedia.com