upport and resistance are very important concepts in the foreign exchange market, awareness of which not only allows you to see the graphical figures but also helps to determine the trend.
By judging the strength of these levels is the basis for predicting the trend and determining its turning point.
Let’s analyse what we see.
The price moves up and then pulls back, the highest point reached before it pulled back is now resistance.
The resistance is a price indicator on the basis of which a sufficiently large number of sales orders is concentrated. They are enough not only to stop the upward trend but they can reverse it, as well.
The support is a price indicator in which strong buying positions are gathered, which can stop the downward trend and turn it in the opposite direction. When the downward trend reaches a foothold, it is like a diver who is reaching the bottom, then he immediately goes up.
Levels of support and resistance are key areas where there is a balance between buyers and sellers, where supply and demand forces are balanced.
In the financial market, with increasing supply, a downward trend is formed, and with increasing demand – an increasing trend.
In a balanced supply and demand format you can observe a sideways trend, the movement of prices in a particular price channel.
The support will be located in the area where the demand for the currency pair is formed, which does not allow its price to fall. From a logical point of view, the phenomenon is explained very simply. As soon as the price falls to a certain level, buyers have an interest in buying. At the same time, sellers are running out of energy to move the price down.
The most basic way how to trade support and resistance are:
Trade the “Bounce”
Buy when the price falls towards support.
Sell when the price rises towards resistance.
Trade the “Break”
Buy when the price breaks up through resistance.
Sell when the price breaks down through support.
Once the price passes the level of support or resistance, it is automatically considered broken and is no longer considered support and resistance.
Support and resistance levels are not exact numbers.
For example, if there is support for the currency pair EUR / USD at 1.0655, it does not mean that you have to wait for the pair to reach this level and buy exactly at 1.0655. Instead, use the area around this level as a support area and look for buyers in this rough area. Depending on how long you monitor this level of support, the zone can be 10 pips for charts during the day and 50-100 pips for the weekly or monthly chart.
Plotting Support and Resistance Levels
Not every time you notice a support or resistance level that appears broken, it will be for real, the market could be just testing it.
With candlestick charts, these “tests” of support and resistance are usually represented by the candlestick shadows.
The Support level is holding at 1.4700.
You can notice that the shadows of the candles tested the 1.4700 support level and the price tried to break out, but it didn’t succeed.
It is called testing a level. And the level held under the pressure of the test.
So how do we truly know if support and resistance were broken?
There is no concrete answer. Some would suggest that this could be the case if the price can actually close past that level.
What if the price actually closed past the 1.4700 support level in the example above.
On these terms, the price had closed below the 1.4700 support level but then it went rising back up above the support level.
You can easily mistake this with a real breakout.
Unfortunately, if you had sold this pair, you would’ve been in deep trouble.
After taking one last look at the chart, you would not only come to the conclusion that the support wasn’t actually broken but also that it is even stronger now.
To help you filter out these false breakouts, you should think of support and resistance more as “zones” rather than concrete numbers.
It is important to pay attention to the fact that technical analysis does not belong to the category of exact sciences.
The final decision of the majority of traders is made on the basis of subjective judgments and assumptions.
In addition, in practice, highs and lows of the same height are rare.
That is why traders not only learn how to determine the levels of support and resistance but also work with concepts as zones, which can be called ranges of price reversals.
The use of zones and levels is determined by each specific situation.
Experts recommend working with contours if prices go in a narrow range of no more than two months. Level zones are suitable when there is a wide range of motion.
Here are some important details you should know about support and resistance levels:
- If the price passes through the resistance level, it is possible for this resistance to turn into a support level.
- If the price tests the level of resistance and support a couple of times and don’t succeed in breaking out, this area of support or resistance becomes even stronger
- If the support or resistance level breaks, the strength of the action of the price as an outcome will depend on how strongly they support or resistance had held
Like everything else, you need to practice in order to be able to spot potential forex support and resistance areas easily.
Let’s talk about trend lines.