Support and Resistance

One of the most important areas I often reference on the Forex Blog are support and resistance levels as “tactical points of interest”.

Support levels are potential “demand” areas where the price is often given to find support as it is declining.

This means the price is more liable to “rebound” off the level instead of pushing through it – all things being equal.  However, once price has passed through the level, by a significant degree it is often likely to continue falling until the next demand level.  A decline beneath a support level is often indicative of a new readiness to sell by the market participants or a lack of motivation to buy until price moves lower.

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Resistance levels are potential “supply” areas where the price is often given to find resistance as it is rising.

This means the price is more liable to “rebound” off the level instead of pushing through it.  All the same, once price has passed through the level by a considerable amount it often has the potential to continue rising until the next supply level.

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The following areas can all be used as support and resistance and are closely watched by price action forex traders:

  • Horizontal price support and resistance
  • Fibonacci retracements and projections
  • Floor trader Pivots,
  • Trend lines
  • Moving averages

This article will focus on the horizontal support and resistance elements.

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How reliable is support and resistance?

One factor to keep in mind when trying to determine support and resistance levels is that it does not always happen precisely at exact numbers (although it can sometimes!).

There can be a short term imbalance, which results in a spike through an area, and novice forex traders sometimes mistake this for failed support and resistance after a subsequent reversion to the recent range.

Chart time and experience helps us make discretionary judgement calls on whether a fake out/spike is taking place or if the area has been broken with reference to the time frame we are trading.  Other factors like the volume traded at a level can help with this analysis on other asset classes but not with forex.

Here are some of the key points I note when looking at a potential support or resistance level:

  • How many touches does the level have?  The more (accurate) touches the more interested I am in the level, as it will likely have caught the attention of other traders and potentially have the associated order flow.
  • How big were the previous bounces off the level.  The more pronounced the better.
  • Did this level form over a recent trading session or a while back?  More recent levels capture my attention but older levels are also noted.  I prefer to look from the right hand side of the chart and draw technical levels accordingly.

Price flip areas – Support becomes resistance and vice versa

Another rule of technical analysis states that support often turn into resistance and vice versa.

After price breaches support, the level can turn into resistance.  A penetration of support often indicates that the pressures of supply have overcome the inherent demand at a given level, so when price returns to the area there is, in all probability, an increase in supply so we now have resistance…

If we really think about it this makes perfect sense.  Fear and greed rule all markets, including Forex, and this is a great example of why.

Imagine you just bought a serious amount of euros and price went against you…  You are potentially holding a huge losing position and it doesn’t feel good.  You bought the euros at a clearly defined support level and wish you never did.  Then, just as you think the trade will hit your stop loss, the euro rallies and moves towards the original entry point.  The euphoria of seeing your hard earned money come back is overwhelming and you think yourself lucky to get away without a loss, close the trade at the previous support level, and breathe a sigh of relief.

While observing charts we sometimes forget what is actually behind every movement in price – people move price!

If this is happening on a large scale (the market) with many traders doing the same we create a resistance level as supply has increased – you create supply when closing the trade.

While observing charts we sometimes forget what is actually behind every movement in price – people move price!

Support has become resistance!

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With practice and chart time, you should be able to see potential support and resistance areas and plan your strategy around them accordingly.

It is our opinion that the best trade entry and exit strategies usually combine support, resistance and price action.

How do you trade Forex?

In the Forex market, you buy or sell currencies.

Placing a trade in the foreign exchange market is simple: the mechanics of a trade are very similar to those found in other markets,  so if you have any experience in trading, you should be able to pick it up pretty quickly.

The object of forex trading is to exchange one currency for another in the expectation that the price will change, so that the currency you bought will increase in value compared to the one you sold.

Example: You have 5000$ Account.
You estimate that the Euro will rise at price versus Dollar.
In that case, if you buy euro against dollar you will gain profit.

The main aspects of Forex market

 

The currency quotation is the cost of the currency expressed in another one (i.e. it shows how the current currency is more expensive than other / in our example on EUR/USD at the quotation of 1.3100 it will show that the EUR is 1.31 times more expensive than USD);

The currency quotations given by brokers usually looks like:

1.3100/1.3103 -this are Bid/Ask prices.

Bid — sell price (You can sell the currency pair at this price)
Ask — buy price (You can buy the currency pair at this price)
Spread — difference between the sell and buy prices (1.3103 — 1.3100 = 0.0003, or 3 points (3 pips))
Lot — the minimum operation value of standard trade contract.
1 lot — 100.000 basic currency (in our example it will equal 100.000 EUR)
0.1 lot — 10.000 basic currency (in our example it will equal 10.000 EUR)
0.5 lot — 50 000 basic currency.
Point (pip) — The minimal change of the currency pairs price.
1 point — 0.01 cent
1 point — $0.0001

What is Spread?

Spread

Spread is the difference between the Bid and Ask prices. In the case of the USD/CAD forex quote mentioned 1.0180/83, the spread is .0003, often expressed as “3 pips”. Forex brokerages often set the spread of currency pairs offered at fixed amounts. For the forex trader, this fixed spread allows for better pricing consistency from trade to trade.

For an example of how this information is used when calculating profit and loss in forex trading, please see the Mechanics of Forex Trading section.

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