When stocks rally, they often meet resistance at price levels that have acted as barriers in the past. This resistance can sometimes cause a stock to reverse direction and head lower. Eli Lilly and Co. (LLY) is a recent example of this phenomenon.
As the stock climbs, it’s in a state of imbalance, with more buyers than sellers. To acquire shares, buyers are forced to bid up the price, pushing the stock higher. However, when the stock hits resistance, the dynamic shifts. There are enough sell orders to match all the buy orders, halting the upward momentum.
In July, Eli Lilly encountered resistance at $955. After a sell-off and subsequent reversal, the stock once again hit this resistance level in August. The reason for this repeated resistance is rooted in investor psychology. Many traders who bought Lilly at the resistance level in July were disappointed when the price subsequently declined. When the stock returned to $955, these investors sought to exit their positions at breakeven, creating a large concentration of sell orders at that specific price. This concentration of sell orders once again formed a barrier at $955.
Sometimes, stocks reverse and head lower after reaching resistance. This is because traders and investors who initially created the resistance by placing sell orders become increasingly competitive. They fear missing out on potential gains and are willing to undercut each other by lowering their selling prices. This snowball effect can lead to a sharp decline in the stock price.
Successful traders understand the importance of investor psychology in identifying key price levels and emerging trends. By recognizing patterns like resistance, traders can gain valuable insights that can potentially lead to profitable trading opportunities.
