Have you heard of price levels in the forex chart that will act like an invisible wall, stopping the market dead in its tracks? Or at other times, they appear to act as springboards and send the price into uncharted territory? Such is the intriguing nature of support and resistance — two cornerstones of technical analysis that each trader needs to know. In this article, we will be taking a comprehensive look at the concepts of support and resistance, why they are important, how to use them and their psychology behind them.
What is Support and Resistance?
Support and resistance are the most basic yet highly recognized notions in technical analysis, which traders utilize to predict possible entry and exit levels. These levels act as psychological barriers that supply and demand forces fight over.
Support: The price level at which price is likely to stop falling, and could even turn back upward, creating a reaction. It is in a way, the floor that supports the market.
Resistance: A price point at which the upward movement of the commodity is usually stopped, and could be reversed if selling pressure persists. Think of it like a roof where the market has difficulty getting over that.
These levels are not arbitrary, they arise from the collective psychology of market participants. Support, for buyers are seen as a chance to buy low and resistance, by sellers as an opportunity to sell high.
The Basics of Support and Resistance in Forex
Understanding their formation and significance can greatly enhance trading decisions.
How They Form
As the price moves up and down, support and resistance levels are formed time and again.
When the market is trending like in an uptrend: Resistance occurs at the maximum peak before a decline and support occurs at minimum trough before upward resumption.
During a downtrend: Support – the lowest point before the price bounces \ Resistance – the highest point.
Why Support and Resistance Matter in Forex
Identifying Entry and Exit Points
Support is used by traders to set-up long positions (buy closer to support) and resistance for short positions (sell closer to resistance).
These levels offer clear price ranges at which you can act on your trades.
How to Set Stop-Loss and Take-Profit Orders
Stop-loss orders, which can only be placed below support and above resistance that limits loss.
Take-profit orders are placed close to but before resistance/support as a means of getting out with profits prior to the formation of a reversal.
Trend Confirmation and Reversals
If the price breaks through that resistance, it could indicate a continuation of an uptrend.
In contrast, breaking through resistance suggests a bearish trend after finding support from above.
When these levels get broken with confirmations you see the reversal of this traders are also finding clues about the direction of market.
Psychological Insights
Support and resistance are manifestations of trader psychology, where the majority see little value at that area, whether it is up or down, creating an essence of balance.
All this behavior of the market is understood in order to anticipate and sometimes behaves at certain levels.
Applicable Across Timeframes
It means that support and resistance are exceptional tools since they are used for all timeframes (scalpers, day traders, long-term investors).
This leads to your ability to be much better at predicting price based on formation and understanding their importance, which means you can reduce risk and increase the opportunity in trading.
The Role of Support and Resistance in Forex Trading
Knowing support and resistance levels is a key factor in determining:
Entry and Exit Points: They assist traders in identifying Points of Entry and exit points, i.e. where to sell or buy.
Risk: These levels can actually help with where to place stops and targets.
Market Sentiment: These embody the aggregate psychology of buyers and sellers.
Traders can make a strategy around it and make money by watching the price action with respect to these levels.
Different Tyy of Support and Resistance
If the same form would work for everyone, year after year, a tool like support and resistance levels can stand. These come in many shape and sizes, such as:
Horizontal Levels
They are horizontal levels on a chart as they represent important psychological price points. Example: A currency pair bounces at 1.2000 several times, then this price is a horizontal support level.
Trendlines
In a trending market, support and resistance can coincide on ascending or descending lines. These trendlines connect one peak to the next in a downtrend and trough to trough in an uptrend.
Moving Averages
Unlike fixed support and resistance levels, dynamic levels such as moving averages (or polynomial regression) adapt over time with price. Traders identify these zones utilizing popular averages the likes of 50-day or 200-day.
Fibonacci Levels
These levels (38.2%, 50%, 61.8%) are based on the Fibonacci series, and they are widely used for identifying support and resistance during a retracement.
Trading Strategies Using Support and Resistance
Traders often use these levels to develop strategies that capitalize on price bounces or breakouts. Here, we explore two effective methods: Trading the Bounce and Trading the Break.
Trading the Bounce
Its an entry strategy that allows you to trade when the price approaches or hits a support or resistance but fails to break it.
Support: Look for a buy opportunity as the price bounces upwards from the support zone.
Resistance: Consider for selling or shorting at resistance and price rebounds down.
Trading the Break
In general, when the price clearly breaks an important support or resistance level – this usually indicates to us a new trend in the nature of this trend.
Support break: It is an indicative of additional drop potential. Look to sell or short.
Resistance break: It signals a likely move higher by breaking the resistance. You can consider going long.
False Breakouts: A Common Pitfall
Breakouts are enticing but can be deceptive. A false breakout occurs when the price temporarily moves beyond a support or resistance level, only to reverse back.
How to Spot a False Breakout:
• Wait for confirmation: Wait till price closes abovethe level on higher timeframes.
• Set indicators: Indices like the RSI or MACD can give extra confirmation of momentum.
• Use Volume analysis: A breakout typically takes place along with substantial volume.
How to Determine Support and Resistance Levels
Here are four practical ways to identify these levels.
Using Historical Price Data
Support and resistance support lines are usually identified through analysis of past price charts. Repeated price reversals indicate significant levels.
Support: Find price levels that they have always come back up after they dipped.
Resistance: Find points on the previous chart where price moved up and then quickly went down
Candlestick Shadows
A shadow (or wick) on a candlestick chart typically suggests a price level. These are short-term highs and lows that indicate measures of support and resistance.
Line Charts for Clarity
Line charts display closing prices, and help clear away some of the market noise. They remove intraday price extremes to make identifying these levels easier.
Zones Instead of Lines
It is more appropriate to regard support and resistance as zones rather than strict lines? A zone represents small price movements when the market approaches an important level
Core Features of Support and Resistance Lines
Dynamic Nature: Support and resistance levels are not static. They transform according to the market environment. If the price breaks above a previous resistance, it may become support and vice versa.
Strength of Levels: The more times a price tests a level and fails to break it, the stronger that support or resistance. But repeated tests can also weaken these levels over time.
Market Sentiment: These levels are really a representation of herd psychology. Traders buy at support believing the asset is undervalued, and sell at resistance seeing it as overvalued.
Psychology Behind Support and Resistance
These support and resistance levels are grounded in the psychology of the market:
Support Psychology: When the price gets close to that level, traders see a buying opportunity as they believe the asset is undervalued. This lead to buying demand which often stops the price from declining any further.
Resistance Psychology: As the price approaches resistance, traders view it as a good opportunity to sell and take profits as they believe the asset is overvalued. Such a selling pressure generally limits the upside potential.
By understanding this psychology, traders are better able to predict how the market will react to these levels.
Tools and Techniques for Plotting Support and Resistance
Key support and resistance levels are the basis of technical analysis. They assist traders in spotting potential turn or stop points for price. Four excellent tools, explained below, with which to plot these levels:
1. Horizontal Lines
Horizontal lines are drawn at specific price levels where the market has reversed multiple times.
These levels act as barriers because traders often place buy or sell orders around them.
For example, if a price level repeatedly stops a downward move, it becomes a support level.
Conversely, a price level that blocks upward movement acts as resistance.
Look at historical price data to identify these recurring levels.
2. Trendlines
Trendlines are diagonal lines drawn to connect significant highs or lows in a trending market.
In an uptrend, draw a line under the price, connecting higher lows. This line acts as dynamic support.
In a downtrend, draw a line above the price, connecting lower highs. This line serves as dynamic resistance.
Trendlines adjust as the market moves, offering traders real-time guidance on potential reversal or continuation points.
3. Fibonacci Retracements
Fibonacci retracements are drawn using key percentages, like 23.6%, 38.2%, 50%, 61.8%, and 78.6%.
Traders use these levels to predict where the price might pause or reverse during a pullback.
To apply Fibonacci retracements, identify a significant high and low on the chart.
The retracement levels are automatically calculated and often align with support or resistance zones.
4. Pivot Points
Pivot points are calculated based on the previous day’s high, low, and closing prices.
They provide a central point (pivot) and additional support and resistance levels (S1, S2, R1, R2, etc.).
These levels are widely used in day trading to predict price movement.
If the price is above the pivot point, it is seen as bullish, while below the pivot, it is considered bearish.
Horizontal lines, trendlines Fibonacci retracements and pivot points are all tools that provide different aspects into the workings of the market. Together, they offer a broader perspective on support and resistance, enabling traders to make informed decisions.
Advanced Concepts of Support And Resistance
1. Support Becoming Resistance
Every time price breaks through a support level, in the future it will often serve as a resistance.
This would occur because the traders who bought at support could be looking to sell their position as price returns to that level so they can break even on lost trades.
For example, If EUR/USD breaks under 1.1000 (support), then that level could serve as resistance the next time prices rise up to it.
When we see this, it is referred to as a role reversal — support becomes resistance.
2. Resistance Becoming Support
Every time price breaks through a resistance level, in the future it will often serve as a support.
This occurs as traders who missed the breakout are now treating what is broken resistance as a good place to enter.
As an example, if USD/JPY breaks above 150.00 (resistance), when price pulls back, traders will view 150.00 as support.
This is also a “role reversal” but in the reverse direction.
3. Confluence Zones
Confluence zone are areas that show multiple factors of support, resistance, and indicators.
This is what makes these zones stronger as they are a confluence of 2 or more different types of analysis which increases the chances of actually making a successful trade.
It means that if a support level coincides with Fibonacci retracement and oversold RSI, it is a buy zone with high probability.
Confluence zones are high probability areas which is why they are favoured by many traders.
These concepts will help you identify better trade setups when certain conditions favor a more favorable climate for the unwanted actions and shift or reflect as needed.
Top 4 Errors to Avoid When Trading Support and Resistance
Never Rely on Support and Resistance Alone
While support and resistance levels good, but not always the simplest you should get the correct amount of context and depth.
We know that many things influence the market price like trends, news and economic events.
If you are looking to make better decisions, use support and resistance with things like moving averages, RSI or MACD tags
So, if a support lines up with an oversold RSI, that bolsters the case for buying.
Ignoring Market Conditions
News and market sentiment have a larger impact on price action
Things like interest rate changes or geopolitical developments can trump technical levels.
For instance, it could blasted through major resistance without stopping during a big announcement.
Do not forget to check the news and what is trending in general market trend before trading at any point of time.
Overcomplicating Charts
If you add too many support and resistance levels, there are no one that can tell them clearly from each other, hence your chart is jumbled with a lot of useless information.
Instead of marking every small level, focus on major zones that the price has tested multiple times.
The goal of price action trading is to keep it clean and simple as this makes it easier to pick the best trades and also avoid mistakes.
But just remember, clarity is king on how you are going to trade those shorts.
And these mistakes can hamper your trading accuracy at the help of support and resistance.
Examples of Support and Resistance
Case #1: The Bounce off of Support
Let's say the EUR/USD has a solid support area at 1.0500.
Each time the price gets near to 1.0500, buyers enter and force it higher.
For instance:
Then price drops to 1.0510 only for buying power to return and push the market back up to 1.0600.
It then tumbles back to 1.0505 and ultimately recovers to 1.0650.
This repeating bounce illustrates that 1.0500 acts as strong support.
Why does this happen?
Traders and investors view 1.0500 as decent level to buy the EUR/USD pair.
They see it as cheap at that level and demand starts coming in.
A trader that observed this behavior may look for buy orders around 1.0500 on their next attempt to bounce off of this level. They may also place a stop-loss order slightly below the support, if they are worried that the support does not hold.
Example 2- Break of resistance
Take for example the GBP/USD starting to fail again at the 1,3000 resistance area.
The price rallies to 1.3000, but then hovers here for multiple days or weeks without being able to move back above it because sellers are in control at this level.
For example:
It is able to get as high as 1.2995 but selling pushes it back down to 1.2900.
It then rises up a few days later to 1.2998 but falls again to 1.2950.
Eventually, there is a day where price powers up and blows through 1.3000, closing at 1.3050 on high volume resulting in breakout.
Why is this significant?
This kind of breakout confirmation requires strong buying interest as indicated by an increased volume.
Sellers have been overrun at this level and the price is now free to move further higher.
GBP/USD bounced to 1.3200 after breaking the resistance
Traders targeting the breakout will be entering long positions at 1.3010 and attempting to ride higher.
The breaking of resistance is an example of a long-term bullish signal, as well as potential capitalisation on upward price trends by traders.
Whether by using these examples, the traders can identify and plan their trade accordingly.
Conclusion
Support and resistance are fundamental concepts in forex trading. By learning them, traders are able to develop a greater sense of price action and derive better trades. Keep in mind that these levels are not a hard and fast rule; they are areas governed by market psychology, and should be used alongside other tools of analysis.
It becomes second nature, your eyes tune into them, and if you know how to play support and resistance after some practice it will be easier for you to make consistent trades.
Did you find this guide helpful? Comment below if you want more in-depth information on any part of forex trading.