Support and Resistance

Support and Resistance defined

Support and resistance (S&R) are terms used by technical traders to refer to currency pair price levels at [or near] which price has reversed its direction on multiple instances in the past, or where price is likely to reverse due to psychological reasons.

In our Bootcamp sessions, we may suggest at times that a rising currency pair will likely “find resistance” in a certain zone. This is a predicted near-term high for price – a “ceiling” where buying pressure will encounter a degree of resistance. If such a resistance zone “holds,” then there are many sellers at that particular price, and they overpower the buyers (who may turn into sellers themselves). Price will dip as long as this selling pressure is present.

Likewise, we also suggest at certain times that a dropping currency pair will likely “find support” in a certain zone. A support area represents a “floor”of sorts where traders expect the buyers to support or hold off the market’s selling pressure. It is a predicted near-term low, and price will rise as long as this buying pressure is present.

Why S&R is important to your trading

Support and resistance levels are a very powerful part of your forex trading arsenal, applicable to both trending and range-bound markets.

· In a range bound market, support and resistance define the lower and upper bounds of price movement. When price approaches resistance, We begin to look for signs that price will be rejected at that level and reverse back down. When it goes down toward support we expect to see price bounce back up off of that support level. This process of bouncing off of support and being rejected by resistance will continue until the range is broken.

· In a trending market, we look to resistance and support as levels where we would enter a trade if price were to successfully break through.

In both cases, if we have valid reasons to trade, either a bounce/rejection or a break of the support and resistance lines, those areas provide us with a great opportunity to take a trade with reduced risk. Why is that? The answer is that once price successfully breaks a support or resistance line, they often switch roles and what was once support is now resistance, and what was once resistance now becomes support.

Identifying support and resistance

Support and resistance is actually found on charts in many different forms. Price channels, fib levels, trend lines, psychological levels, horizontal S&R lines, and even moving averages all represent support and resistance to one degree or another. Some are more specialized versions of support and resistance, and their strengths vary depending on current market conditions. This lesson focuses on horizontal S&R lines (the other support and resistance methods are covered in separate lessons).

A horizontal resistance line is established by connecting at least two significant high prices occurring at approximately the same level. A horizontal support line is drawn by connecting two or more significant low prices occurring at approximately the same level.

General rules on support and resistance

The more it holds, the tougher to break—The more often price tests a level of resistance or support without breaking it, the stronger the area will be.

Role Reversal—When price breaks above a resistance level, it is common to see that level change its role and become a new area of short-term support. For example, in the figure below, the dotted line represents a level of resistance that has prevented price from moving higher on two prior occasions. Once the resistance level is finally broken, however, it becomes a level of support.

Similarly, when price breaks below a support level, support often “becomes resistance.” For example, in the next figure, the dotted line indicates a support level which has kept price from moving lower on two previous instances. However, once the support level is broken, it becomes a resistance level.

Long-term trumps short-term—Support and resistance levels on longer-term charts (e.g. one-hour, 4-hour, daily charts) tend to be stronger than those determined by inspection of a 15-minute chart.

Don’t overdo it
There are two things to be careful of when working with support and resistance. The first would be identifying too many support and resistance lines. Having too many S&R lines can have the result of preventing you from entering the market when the market is ranging, or believing that a breakout has happened before it actually has. Instead, try to identify major areas of support and resistance and work with those, instead of trying to identify every area where price paused.

The second item to be careful of would be working with obscure S&R lines. As with much of technical analysis, S&R levels work because traders use them. When identifying areas of support and resistance, focus on those which are obvious. Support and resistance is a psychological struggle to find balance. As such it needs others to be aware of the level to react to that level. If you are the only one aware of a given level, it is highly unlikely that price will react at all to that level.