Support and Resistance

 

Support and Resistance Levels in Forex

One of the most commonly used concepts in forex is support and resistance.  Everyone has their own way on how one should measure support and resistance.  Let’s consider the basic concept...

When the overall line is going up, the zigzag pattern is on an upward trend.  When the market moves up and then pulls back, the resistance is the highest point reached before it pulls back.  The lowest point reached before the market pulls back is the support.  The forex market oscillates over time, so support and resistance are constantly formed.  The opposite is also true for the downtrend.

 

Plotting Forex Support and Resistance

Levels of support and resistance are not exact numbers.  The market has a way of testing support and resistance levels, often times they appear broken.  These ‘tests’ are usually represented by candlestick shadows.

When the price goes below a certain price (often more than once), but generally stays above it, the shadows are testing the support level.  It may look like the market was ‘breaking’ support, but in reality it was just testing it.

 

How to Test if Support and Resistance Levels are Broken

Although there is no definite answer to this, some say that if the market can actually close beyond that level, then the support or resistance level would be considered broken.  However, that is not always the case...

Sometimes, even after the price had closed below the support level, it can end up rising back above it.  If you would have sold this pair believing that there was a real breakout, you would of lost money.

It helps to think of support and resistance as zones rather than concrete numbers.  Line charts are a good way to find these zones and plot support and resistance levels.  This is because line charts only show the opening and closing prices, while candlestick charts also show the extreme highs and lows.

Intentional movements are the only thing you should be plotting when dealing with support and resistance levels.  Reflexes in the market can be very misleading.  Look for areas where you see the price forming several peaks or valleys, and plot your support and resistance lines around those areas.  

Other key things to remember when dealing with support and resistance are listed below.

  • If the price passes through resistance, it’s possible for that resistance to become support.
  • The more times a price tests a level of support and resistance without actually breaking it, the stronger the area of support or resistance is.
  • When levels of support and resistance break, the strength of the follow-through move depends on how strongly the broken resistance or support has been holding.

 

Trend Lines

The most common form of technical analysis in forex trading are trend lines.  It is vital to draw them correctly, because many forex traders don’t.  Some traders attempt to try and make the line fit the market, when it’s supposed to be the other way around.

The trend line is drawn along the top of easily identified resistance areas (peaks) in a downward trend.  In an upward trend, the line is drawn along the bottom of support areas (valleys).

3 Types of Trends

  1. Downtrend (lower highs)
  2. Uptrend (higher lows)
  3. Sideways trends (ranging)

Other Important things to Remember with Trend Lines

  • You need at least two tops or bottoms to draw a trend line, but to confirm a trend line, you need three.
  • When drawing trend lines, the steeper it is, the less reliable it will be and more likely it will break.
  • Trend lines become stronger the more times they are tested, just like horizontal support and resistance levels.
  • NEVER force trend lines to fit the market.

 

Channels

Channels are created when parallel lines are drawn at the same angle of an upward or downward trend.  They are a technical analysis tool that help determine good places to buy or sell in the market.  The tops and bottoms of channels show potential areas of support or resistance.

Draw a parallel line at the same angle as an uptrend line, and then simply move that line to position where it touches the most recent peak to create an up (ascending) channel.  Do this at the same time you make the trend line.

Draw a parallel line at the same angle as the downtrend line, and then simply move that line to position where it touches the most recent valley to create a down (descending) channel.  Once again, do this at the same time you make the trend line.

Buying areas can be pointed out when prices hit the bottom trend line.  Selling areas can be pointed out when prices hit the upper trend line.

3 Types of Channels

  1. Descending channel (lower highs and lower lows)
  2. Ascending channel (higher highs and higher lows)
  3. Horizontal channel (ranging)

Important Things to Remember

  • Both trend lines must be parallel to each other when constructing channels.
  • The top of the channel is considered a sell zone, and the bottom of a channel is considered a buy zone.
  • Never force the price to the channels that you draw.

 

The Bounce and the Break in Trading with Support and Resistance

The Bounce

It is a common mistake for retail traders to set their trades directly on support and resistance levels, and then wait for their trades to materialize.  It may work at times, but you are assuming that either level will hold without the price actually getting there yet.

We want to tilt the odds in our favor when using the bounce in order to find some kind of confirmation that the support or resistance level will hold.

Wait for it to bounce first before entering, instead of buying or selling right from the get-go.  This allows you to avoid moments where the price moves fast and breaks through support and resistance levels.

 

The Break

When support and resistance levels give way, they break.  There is the aggressive way to play breaks and the conservative way.

 

The Aggressive Way

  • Buying and selling when prices convincingly pass through a support or resistance zone is the easiest way to play breakouts.  
  • However, make sure you only enter when price passes if there is a significant support or resistance level.

 

The Conservative Way

  • Let’s say you go long on USD/EUR with hope that it would rise after bouncing from a support level.  Then the support breaks and you are in a losing situation.  If you held onto your trade in hope that the price would rise again, then you would be taking a conservative approach. 
  • Closing out a position means you are taking the opposite side of the trade.  So if you close your USD/EUR trade at near or break even then you would have to short the USD/EUR by the same amount.
  • Price will reverse and start falling again if enough selling and liquidation happens of losing positions at the broken support level.  This is why broken support levels become resistance whenever they break.
  • The conservative way is all about patience.  Wait for the price to make a ‘pullback’ to the broken support or resistance level instead of entering right on the break.  It is better to enter after the price bounces.
  • This doesn’t happen all of the time, and sometimes the price will just move up leaving you behind.  That is why it’s always good to use stop losses.  Never hold onto a trade in desperate hope.

 

 

 

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