Forex Support and Resistance Explained
Last Updated on Feb 24, 2019
A forex trader is nothing without his arsenal of analysis tools, and support and resistance levels should definitely be included in yours if you want to meet success in this field, for they provide a clear vision as to how the market is moving and can be a great aid when you’re trying to decipher its mysteries.
To put it simply, you can’t take care of your technical analysis properly without using these two levels. When used alongside charts and other tools, they can reveal market patterns and help any analyst understand the future of the market
Nothing is guaranteed though, as the Forex market is blessed, or rather cursed, with a high velocity, and considering how many factors are included, future results can differ from past performance. Keep that in mind, and your journey will become much more comfortable, with all its successes and failures.
What Are Support and Resistance Levels?
In simple words, support and resistance levels represent two specific zones on the chart. If the price reaches one of these zones, it’s most likely going to bounce and move either in the opposite direction of the trend or into a consolidation. That’s not it though, as the price can also witness a major breakout or rapid movement in the same direction upon reaching one of these levels.
Support and resistance levels reflect the probable attitude of the different market players when the price reaches a certain level.
In other words, they are more of psychological levels rather than fact-based ones.
In plain English, support and resistance areas are war zones, where the market players are split in half; some believe that the Forex pair will go up, while the others speculate that it’s going down.
When the interests of the two sides intersect, the situation turns into a Tug of War game, where every team is trying to get the market to move in their direction and get the other side in the mud puddle. As there cannot be two winners in this game, a clash arises between buyers and sellers, and whoever wins will push the market in their direction, leaving the other side in a loss.
What differentiates support and resistance levels is the ratio of buyers to sellers.
The support level is reached when the currency can’t fall below a certain price point, which reflects a higher number of buyers compared to sellers due to the drop in the value that the currency has witnessed. When this level is reached, buyers intervene by making purchases to create a floor and stop the price from going even lower.
On the other hand, the resistance level is reached when the currency can’t go beyond a certain price point, which is a result of the number of sellers being higher than that of buyers as a consequence of a sharp increase in the price of the currency.
As the name indicates, support and resistance are levels, not specific values. They represent two areas that include a range of price points. These areas can be breached without being broken, which is why they can identify potential spots on the chart where the price may bounce and move in the opposite direction. You may notice a broken support or resistance level from time to time, but it’s most likely just a test by the market.
As with any other tool in Forex trading, there is no exact blueprint through which you can identify resistance and support levels. Doing so requires using your brain to find the recurring patterns in price charts and analyzing how the market players behave in these patterns.
As hard as it may seem, you can still do it and become proficient in identifying resistance and support levels through practice and continuous testing. Should you be consistent, you’ll be able to draw your support and resistance levels on any chart in no time.
Major and Minor Support and Resistance Levels in Forex Trading
Support and resistance come in two types; minor and major levels. While the first can be breached without causing a significant change on the chart, a breach in the latter is more likely to influence the price’s direction and get it to bounce and go in the opposite direction.
Experts use minor support or resistance levels for analytical purposes. For example, if a price breaches a minor support level and keeps going down, it means that the downtrend is intact and is most likely to continue.
Major or strong support and resistance levels, on the other hand, represent price ranges that have caused a recent trend reversal. A major support level is when downtrend reaches a particular value and turns into an uptrend, while a major resistance level is when uptrend gets reversed to a downtrend upon reaching a specific price.
In other words, when the price reaches a major support or resistance area, it usually struggles to breach the level and bounces in the opposite direction. Keep in mind that the price can eventually break strong support or resistance levels, but it’s most likely to retreat several times before doing so.
The primary trading strategy when using support and resistance levels is buying near support in uptrends and selling or short-selling near resistance in downtrends, given that you’ve gathered enough signs indicating that the price is indeed bouncing.
False Breakouts: Don’t Let the Charts Fool You
You may have a noticed that the currency values might exceed the support or resistance levels sometimes, moving further than expected, before reversing to the opposite direction. That event is a called a false breakout.
If your analysis shows resistance at 1.4958 – 1.4975, it’s totally normal for the price to go a few pips higher before collapsing, because support and resistance are, as mentioned above, whole areas, not exact values.
So, when the price gets close to a resistance or support level, don’t panic if it does breach the level and exceed last time’s value, as it is unlikely for it to stop at the exact value every time. In other words, consider that you may be witnessing a mere false breakout.
For professional traders, false breakouts represent excellent opportunities to earn a few extra bucks every time by waiting for one before entering the market.
That is a strategy you can follow yourself, and the concept is quite simple; If the trend is down and the price is pulling back to resistance, wait for it to break above resistance level and short-sell the moment it starts to drop down again. On the other hand, if the trend is up and the price is pulling to support, wait for it to break below support level before buying when it starts to rise again.
Breakouts and Breakout Trading: The Pressure Strategy
While it’s more common to witness false breakouts where the price reverse and moves in the opposite direction after breaching a support or resistance level, it’s also possible for a breakout to persist when the support and resistance levels are weak enough, thus turning the resistance into support and vice versa. That phenomena have been more common in recent years as the concentrated areas of buying and selling pressure started to become diluted.
Breakout trading is another strategy that many professional traders use, where they attempt to enter the market as the price breaches either the support or resistance level.
How do they determine if it is indeed a genuine breakout, you may ask? By checking whether the breakout is accompanied with increased volatility, which is graphically presented by big candles.
Basically, the simplest breakout trading strategy is selling or buying when the price breaches a support or resistance area in a convincing manner, following the above rule of thumb.
However, it’s a risky and aggressive strategy, and we certainly don’t recommend it, especially if you’re new to this game.
What you should do instead is wait for a subsequent pullback after the breakout, where the price returns to the support or resistance level, then enter as the price bounces back. That way, not only will you play it safe, but you’ll be sure to maximize your profits.
Support and Resistance levels are yet another tool that you can use during your Forex trading journey. As mentioned above, there are a lot of ways to integrate these concepts as part of your technical analysis, so it all boils down to how consistent and willing you are to learn and test new things.