Support and Resistance levels: How they help Forex traders
SUPPORT AND RESISTANCE LEVELS: HOW THEY HELP FOREX TRADERS
Learning how to find support and resistance levels is one of the most crucial skills forex traders must acquire. Support and resistance levels are a fundament component of forex trading.
In short, support and resistance levels are points on a technical chart that act as psychological barriers for entry and exit points.
- Support is a level below the current price.
- Resistance is a level above the current price.
Support and resistance trading are facilitated by technical charts and indicators. To minimise risk on trading forex on support and resistance levels, traders must isolate as many false signals as possible to work with true readings for potential trading opportunities.
What is support and resistance in forex trading
Support and resistance can be likened to the game of tug-of-war in the forex market. To help you visualise support and resistance levels, you can think of the bears and bulls of the financial market fighting for dominance on a position in the forex market.
- Bear traders sell underlying assets in order to buy them cheaper in the future. The bearish market is the opposite of a bullish market because the bears want the underlying asset to depreciate and lose its value.
- Bull traders believe that the value of a currency pair will increase in value over a specific period of time. It’s rare for the forex market to be bullish as a whole because there are so many currency pairs trading on the forex market that are subject to fundamental and technical factors. However, a bullish currency will occur where the bulls expect the underlying asset to appreciate and increase in value.
They are specific levels on a trading chart that indicate where a price of a currency pair finds opposition. They are referred to as psychological levels because they reflect different attitudes of participants in the forex market.
The support and resistance zones are where the interest of the different market participants intersect. In other words, interest for the currency tugs against the lack of interest in the currency until the weaker one loses and is pulled off its feet by the stronger currency.
When a price reaches a confirmed support and resistance level, it can either springboard in the opposite direction of a trend or consolidate on a horizontal level. The level is ultimately broken (either the bear or bull wins the tug-of-war game) and moves in one direction or another on an uptrend or downtrend.
What is a support level?
When currency prices stop falling, change direction and begin to rise again, they are in the support zone. Support is often referred to as the ‘floor’ that supports the currency price and prevents it from falling further. Basically, support is the psychological level that holds up the currency price.
What is a resistance level?
When currency prices stop rising, change direction and begin to fall, they are in the resistance zone. In contrast to support being the floor, resistance is viewed as the ceiling. This is the psychological level that will prevent the currency price from continuing to rise.
Difference between support and resistance?
Using the analogy of floors and ceilings, support is the level that can be drawn beneath the current price. Resistance is the level that’s drawn above the current price.
Support and resistance levels are interchangeable. The support level can quite quickly become the resistance level and start acting as a level with opposite force.
- When the currency price moves down through a support level and breaks it, this level becomes the new resistance level.
- When the currency price moves up through the resistance level and breaks it, this level becomes the new support level.
Why support and resistance levels are so important
Learning how to open and close positions in the forex market using support and resistance levels is one of the most important things you’ll do when you start trading forex using a demo account. The exercise incorporates somewhat complex technical charts and indicators but don’t let those confuse you too much.
If you think of the support area as being the floor of your forex house and the resistance area is the ceiling, then think of the price as a bouncing ball. The ball will naturally bounce between the floor and the ceiling, all the time testing the strength of the support floor and the resistance ceiling.
Sometimes, often when you least expect it, the bouncing ball becomes a much heavier bowling ball and breaks through either the support floor or resistance ceiling. Forex prices either hold at a level or bounce off the level in a predictable direction; otherwise they drop through the support zone or break through the resistance ceiling.
Technical charts represent historic data on price movement but they are not designed to predict the future. Support and resistance levels serve purely to interpret where the price will hold or break through the barrier. Interpretation of support and resistance levels is key to successful forex trading.
How to find support and resistance levels
Support and resistance levels are very easy to find using trendlines and moving averages on technical charts.
The bottom of the chart is a potential support and the top of the chart is a potential resistance. They are potential support and resistance to start with and only become actual support and resistance when the price conforms to its level more than once. In other words, reveals itself as a pattern or trend.
When the currency price drops to a level and then goes back up again, this is called the eventual point. If the pattern repeats itself, traders know it has found opposition. When the price bounces again from this level, traders can confirm it as support.
The same applies to finding the resistance. If you see the price bouncing against an overhead level more than once, you can assume it’s found resistance. Forex traders are only concerted with finding valid support and resistance levels that have proven themselves to be authentic and a potential trade opportunity.
Forex traders look for reliable support and resistance levels to help them find a successful entry and exit point on positions. Technical analysis that captures historic price movement data is used to find older levels that have been tested and validated a few times.
How to set entry and exit points at support and resistance levels
Support and resistance helps forex traders find entry and exit points on the charts for trade positions. This forms the basics of opening and closing positions for successful trades. Regardless of what trading strategy you adopt, every forex trader constantly refers to support and resistance levels and the price action around these levels.
Remember, support takes place where a downtrend is expected to pause due to a concentration of demand. Resistance takes place where an uptrend is expected to pause temporarily due to a concentration of supply.
Finding the entry and exit point is a study of psychology. At what point will the market react to changing trading conditions and the price movement will absorb the prevailing market sentiment?
Setting entry points on support and resistance levels
The aim is to find a reliable support level. When a currency pair approaches an established support zone and you note that it’s an old and tested support, the temptation is to set an entry point when the price touches the support level. The wise thing is to wait for the price to interact with the level first.
When it interacts with the support level, you can enter a long position. However, only enter at this point if the price bounces in a bullish (upward) direction from the level. Place your Stop Loss right below the support zone. This will limit your loss in case the bounce is fake and the support breaks through in a bearish (downward) direction.
Setting exit points on support and resistance levels
To set an exit point on a support or resistance level, you would already be in the market with a long (buy) position. If you spot a resistance level, it makes sense to set an exit point to protect yourself in case the currency price bounces in a bearish (downwards) direction. You would set your exit point below the resistance order to avoid any loss off the profit you’ve already gained.
If the price finds resistance and drops rapidly, your Stop Loss saves you. If the price breaks the resistance in a bullish direction, you can always re-open the long position.
How support and resistance can help you trade forex
The most important thing to remember when trading forex on support and resistance levels is they do give false signals every now and then. If you trade forex using the price action strategy, you will wait to confirm the signals are real. You do this using trading tools such as candle patterns, chart patterns, oscillators and momentums.
Otherwise, it’s a case of going with the flow of the forex market. This means going long (buying) when the currency prices approaches a support area and start re-bounding in a bullish direction; and going short (selling) when the price touches a resistance area and starts re-bounding in a bearish direction.
Another strategy is to buy when the price breaks resistance and sell when the price breaks support. The assumption is the currency prices should bounce between the floor and the ceiling and the trick is to know when it will break through the floor or the ceiling.
Two ways to trade forex with support and resistance levels
There are two very simple ways to trade forex with support and resistance levels; play the bounce or play the break.
Play the bounce
The most common method of trading support and resistance levels is setting a trade order right after the bounce. Many retail forex traders make the mistake of taking a position on support and resistance levels without waiting to see what materializes.
Basically, this is playing the ball on the line before the price action makes a definitive move. When you play the bounce, you need to anticipate which way the price will move and find any data from the technical charts that will corroborate you gut feeling.
Play the break
Forex prices often break through support and resistance levels. They don’t hold their range forever. Forex traders approach the breaks in two ways: aggressively or conservatively.
The more aggressive approach to breakouts is to buy and sell whenever the price breaks through a support or resistance zone. You only want to do this when the forex price passes through the support or resistance level with ease. In other words, it’s not a fake break.
The conservative way is to weather the break on a long position and hope the price normalizes over a period of time to offset your losses and regain your profits.
Bear in mind that, if enough of the currency is bought or sold at the breakthrough level, the price will reverse itself and start increasing or decreasing again. If you can afford to wait it out, that’s often the only choice you have. Otherwise, you have to cut your losses and take the hit on any profit you gained.
If you weren’t already in a position and want to enter on the break, it’s best to wait for the price to pull back to the broken support or resistance level. In other words, enter after the price bounces. Either way, use your Stop Loss to prevent a free-fall of losses on the breaks.
How to set a Stop Loss on support and resistance levels
Forex traders, particularly beginners, listen to what the technical charts tell them when it comes to setting Stops on support and resistance levels. There are times when prices of a currency pair can’t break through certain levels. At other times, the support and resistance areas hold the price back from pushing through.
Setting Stops beyond the support and resistance areas is wise because if the market does trade beyond the areas, the break will bring in more participants which will cause you losses against any profit you’ve gained.
The general aim is to set your Stops on a long position below the trend line and support areas. If the market moves into these areas, the buyers are no longer supporting the currency and sellers are now active. If you’ve left it too late, you will have to exit the position and accept the loss. Hopefully, your Stop gets you out early before this happens.
Forex Trading Africa Disclaimer
Trading forex is associated with high risks and can lead to investors and traders losing a significant amount of money. The information in this article should only be used to educate yourself on how forex trading works and the pros and cons of trading on support and resistance levels.
Pay due caution to the risks involved in forex trading and take the necessary precautions to avoid losing capital on forex positions.
15th Oct 2020
12th Oct 2020
12th Oct 2020