All You Need To Know About Support And Resistance In Forex
For you to understand price trends and chart patterns, you need to pay attention to support and resistance zones.
If you’re learning technical analysis for the first time, move “understanding support and resistance” to the top of your to-do list, if it’s not already there.
Already know and use technical analysis? Did you draw a support or resistance zone recently without seeing the logic behind it?
Sure, you’re okay with the textbook definitions, but do you know the reason the price tends to change direction at these seemingly random levels? Could you convince a friend that drawing lines on the chart and expecting the price to reverse isn’t meaningless hocus-pocus?
Regardless of your situation, you’ve come to the right place.
This complete guide on support and resistance zones in forex will make you feel confident about the topic. We know you’re super busy; that’s why this article is easily digestible and well-organized.
You can use the jump links below to navigate to the points you’re the most interested in:
What Is Support and Resistance in Forex Trading?
Let’s start with the basics.
What exactly are support and resistance? How do they work?
Simply put: These are zones on the chart where the current price trend is more likely to reverse or pause.
A support means a price zone where buyers are expected to be strong enough to turn a downtrend.
Conversely, a resistance marks a price zone where sellers might be able to reverse an uptrend.
Now, it’s easy to look at the middle of your chart and say how well support and resistance zones work. However, there’s a lot of uncertainty involved when you have to deal with them in real time.
The reason?
Unfortunately, the price can ignore these zones, especially when the trend is strong. That’s why we love to attach the “potential” qualifier to all support and resistance zones.
That is to say,prices are not approaching a resistance area; they are approaching a potential resistance area.
When a resistance or support zone is broken, its role is reversed. In other words, once a resistance zone is broken, it becomes support, and vice versa.
We know what you are thinking: Okay, but how and why does resistance becomes support? It doesn’t make sense.
Well, it does make sense. Let us explain:
At the previous resistance zone, many traders sold hoping the price would go down and they could make a profit on their short positions.
The problem is that it didn’t go down.
The result?
Most of those traders who sold at that level are now sitting in a losing position.
If the price pulls back to the same level, they will be at breakeven. Of course, many of them will rush to close their short positions to reduce further losses.
If you have read our guide on how forex trading works, you know that to cover a short position, traders need to perform an opposite order.
As a result, the previous sellers now become buyers at the same level.
Here you go!
This is how resistance becomes support, and you can simply reverse engineer this explanation for how support becomes resistance.
On each chart, there are plenty of support and resistance zones, like floor and ceiling with price sandwiched between them.
Support is always located below the current market price while resistance is always located above.
As the price progresses and breaks through the zones, they naturally change roles.
Why Support and Resistance Work
Support and resistance work because people have feelings and memories.
If that sounds confusing, here’s an example that should put things in perspective.
Let’s say you’re planning to sell pizzas.
When people want to buy pizza, they have an expected price range in their minds. Depending on the location, quality, and brand, they are willing to buy a pizza anywhere between $8.99 and $15.99.
But, what if your pizza is really excellent and you want to charge $29.99?
Crickets.
Getting 30 bucks for a pizza sounds fantastic, but it’s so overpriced that there would be no buyers.
Now, what happens if you offered your pizza for $1.99?
People probably wouldn’t believe that you are a legitimate seller, but even if they did, you would be crazy to sell for such a small amount of money. There are costs to cover, not to mention that you want to make money at the end of the day.
The current price range of $8.99 – $15.99 is a temporary consensus between buyers and sellers about the worth of a pizza.
For that money, pizza makers feel they’re getting paid and people feel they’re paying a fair price.
Translated into trading language, the $8.99 and $15.99 act as support and resistance. These are psychological barriers, preventing the price of the asset from getting pushed in a particular direction.
Over time, people might pay $29.99 for a pizza, but it takes a few barriers before the price can get to that level. For instance, future price ranges could be:
* $9.99 – $19.99 then,
* $11.99 – $21.99 and finally,
* $13.99 – $29.99.
The trend of a currency pair in the forex market is also dictated by supply and demand. Besides, markets have so many influences and so much noise that prices frequently stop at random levels.
This, coupled with our tendency to find patterns in random data, causes support and resistance areas to appear on charts.
Because a large number of people see particular price levels as important, by de facto, they become important. Perhaps, this is the simplest explanation of why they work.
It also makes sense if you think about it:
If you see on your chart that prices have recently stopped falling and have turned up from a certain level, you will be more likely to buy the next time prices approach that level again.
Similarly, if you see that an uptrend has recently reversed after rising to a certain peak, you will likely sell when prices approach that level again.
Another critical thing to consider is theemotional factor:
Imagine that you have bought a new jacket for $80 then two blocks away, you see the same jacket for $50.
Feels bad, right?
Support and resistance zones are PACKED with the strongest emotions, such as pain and regret. Some missed an opportunity, others were on the wrong side of the market, and the list goes on.
In short, there are many traders eagerly waiting to take some action around these areas, which makes them super important.
How to Find Support and Resistance Zones
First of all, open a chart on your trading platform and look for areas where price has repetitively changed direction in the past.
Mark these visually with drawing tools, for example, you can use horizontal lines or rectangles.
If you’re like most traders, you prefer horizontal lines. There’s nothing wrong with that, but you should keep two things in mind.
First,you’re dealing with zones, not exact price levels.
It is pretty unrealistic to assume that the price will stop and turn right at your line.
That said, it’s way more likely that the price will stop ahead of the level or go through it before turning back a little further.
Second,extreme prices are less important.
As Dr. Alexander Elder says in his book,Trading for a Living, extreme prices reflect only the panic among the weakest traders.
That’s why it’s better to draw your lines to congested areas with as many touches as possible.
These are the areas where masses of traders changed their minds.
PRO TIP: Round numbers tend to be critical psychological levels. These are easy to remember; therefore, they are often used by traders to set profit targets and stop losses.
Oh, and wait a minute!
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What Is Dynamic Support and Resistance? Many traders use some sort of moving averages to plot support and resistance areas. These are called dynamic support and resistance because they change as the price progresses. As you know, each price is a temporary consensus between buyers and sellers about the worth of an asset. A single price doesn’t tell you whether people are optimists or pessimists – just as a single photo of you doesn’t tell whether you’re an optimist or pessimist. However, if you investigate dozens of photos, you get a pretty lovely picture about yourself. In essence, the moving average is a composite photograph of the market that reveals the mood of the crowd. In a downtrend, the moving average line usually acts as a resistance. In an uptrend, the moving average acts as support. The most popular choices include the 9-day, 50-day, and 200-day moving averages (simple or exponential, depending on your preference). As you can see in the examples above, the price bounced almost exactly from the averages, but of course, it’s not always the case. Hoping for better performance, some traders combine two moving averages thus creating a responsive zone in which the price is expected to change direction. Dynamic support and resistance are most often used to enter trends after a brief correction. Their huge advantage is that they’re always on your chart. You don’t have to bother yourself with looking for new support and resistance areas over and over again. The drawback is that while significant price levels are clearly visible to everyone, moving averages have so many types and settings that fewer people see the same values as you do and therefore, they can be less reliable. How to Trade Support and Resistance The general theory is to buy at support and sell at resistance. You may be asking, is it that simple? No, of course, not. As it usually happens, there are many different ways to do this. In the following, we’re going to take a look at two popular strategies. The first strategy aims to take advantage of situations when the support or resistance level seems to hold. On the other hand, the second strategy attempts to join the trend, once the price breaks through the zone. Support and Resistance Failed Breakout Strategy This set-up usually occurs when an overextended trend approaches a support or resistance area. The price breaks through the zone, but there’s no real buying or selling pressure that would keep the trend going. So, what happens? The failed breakout leaves many traders trapped in a losing position, and soon, the downward movement is accelerated by a flood of stop-loss orders. This quick and energetic move can lead to a trend reversal. Reversals are great because they offer trades with excellent risk/reward potentials. But, that is true only if you’re able to catch them before it’s too late. With that said, let’s see the trigger for this strategy! Short position: The market trades above a resistance zone but reverses on the same or the following candle and closes under the resistance. Long position: The market trades below a support zone but reverses on the same or the following candle and closes above the support. Super-duper easy. In both cases, look at the price action. Ideally, a reversal candlestick pattern such as the engulfing or the hammer should emerge. If the candles are very short and the market seems to be sluggish, you may don’t want to take the trade. The stop for this strategy must be placed beyond the extreme point of the candle that broke the furthest into the zone. For instance, in the picture below, your stop would have been placed above the high of the circled candle. At the same time, when there’s only one candle, you can simply put your stop slightly beyond the extreme point of that. The profit target is more flexible; basically, you can put it wherever you feel appropriate. Unfortunately, there’s always a possibility of a more prolonged correction that may lead to the recovery of the original trend. In general, if you want to trade significant trend reversals, you need to be prepared to handle many small losses before occasional big wins. Keep in mind that this is an aggressive strategy that trades against the trend. Cut your losing immediately or you can quickly get into trouble. Support and Resistance Breakout Strategy As you already know, support and resistance don’t hold all the time. In fact, they break quite often. Some of these breakouts will fail, but not all of them. When the trend is healthy, the price can break through these zones and keep on moving. This strategy will help you get on board and go with the flow. Here’s the set-up: The market has successfully broken out of an important zone. (The way you can assume that the breakout was successful is by noticing that there is a significant price action beyond the level.) Soon, the initial enthusiasm decreases, and the market pulls back to the zone. The ideal pullback has low activity and lack of strength in the countertrend price movement. Remember that zones which previously acted as support expected to become resistance once price breaks below them. Similarly, zones that formed resistance will be expected to act as support. After the pullback has occurred, wait for a strong signal in the direction of the trend. That way, you can confirm that the zone shifted its role and there’s less likelihood of a false breakout. Once you get the signal, you can enter into trend direction. Place your stop-loss somewhat above the resistance or below the support. Your profit target is flexible with the shielding fact that you’re now trading in the direction of the trend. You can aim for a fixed return or take partial profits as the trend progresses. It’s up to you. How to Rate the Strength of Support and Resistance Zones You know that support and resistance can break. We have talked about it in this guide, and you probably knew it even before. But what if we told you some zones have a higher likelihood of holding than others? That’s right. And in the following, we’re going to show you how to rate them according to their expected strength. You need to be familiar with something called multiple timeframe analysis. If you know what it is, great! If you don’t, it means that besides your preferred timeframe, you take into consideration what is happening on other time frames. The question is, should you analyze all the timeframes? Well, you don’t have to analyze ALL of them, but it would be a mistake to ignore the bigger picture. Typically, multiple timeframe analysis involves the use of three different timeframes: – Long-term, where you identify the main trend and the strongest zones. – Medium-term, where you identify smaller moves and medium-term zones. – Short-term, where you find entry and exit points. In general, support and resistance zones are more significant on higher charts. Trends on these charts need a long time to develop and consequently, they need a substantial price move to change direction. Makes sense, right? Now, here’s the thing: What you see as a strong downtrend on the hourly chart can be just the correction of the uptrend on the daily chart. It’s likely that once the daily price action gets to a support zone, the price will stop falling and the uptrend continues. By marking the daily support zone, you can predict when the hourly downtrend will end. Pretty cool. Of course, if you’re a long-term trader, you will use a different set of charts to a day-trader. Here’s a picture to give you an idea about the charts you’ll need: Pick the charts that make sense to you and go ahead with a more comprehensive analysis.