SUPPORT AND RESISTANCE FOREX TRADING
- How levels appear on the chart
- Why is it important to identify support and resistance levels in trading?
- Does the Forex market have support and resistance level?
- How do you calculate support and resistance?
- What happens when support and resistance meet?
- Which time frame is best for support and resistance?
- A level is a specific price level at which the chart can change direction.
- A support level, or simply support, is a price level from which price reverses on a top-down approach. This level seems to support price, preventing it from going lower.
- A resistance level is a price level that turns around on approaching from downward or upward. This level seems to resist the price, preventing it from moving higher.
- A mirror level is a level that acts as both support and resistance.
In practice, such a strict classification of levels is not necessary. It is enough to understand that a level is a point where the price can change its direction with some probability.
According to the classics of technical analysis, there are two possible outcomes at this level: a breakout or a bounce. When either of these occurs, it sets further momentum in the direction of the move.
How levels appear on the chart
Levels are used as a reference point in situations where fundamental factors don´t allow a particular price value to be identified as a starting point. They are most useful in short-term trading when within a random fluctuation one has to identify prices which are currently “too low” and attractive to buy, or “too high”, and when they are reached, it is better to think about selling.
In other words, levels exist because market participants are guided by them when making trading decisions.
Levels can be formed naturally, as a result of an imbalance of supply and demand at certain points, or artificially, as a result of large bids. In general, all types of important levels can be used in trading to open and close positions, as well as to determine the price for a stop bid.
Why is it important to identify support and resistance levels in trading?
Based on the above examples and the experience of professional traders, can highlight seven main reasons why understanding the location of support and resistance lines is important for a trader:
- It helps to understand the market picture as a whole.
- It is necessary for trend analysis
- It is used for early warning of a trend reversal
- The reaction of price to key levels allows us to determine the mood of market participants
- They are often used in trading plans as guidelines for goals, entry and exit points, and stops
- They are used as filters of false signals and confirmation of true ones
- Simplifies end-to-end analysis when working with multiple timeframes.
Does the Forex market have support and resistance level?
A line that price cannot break up is called a resistance line, and a line that price cannot break down is called a support line.
The resistance line of a currency is nothing more than a psychological level, which a large number of traders regard as a point in which is profitable to sell the currency. Such unity of opinion of a large group of people leads to the fact that when prices approach the resistance line or level a large number of market participants begin to sell the currency using orders which are placed at a market or using pending orders which are being executed by dealers.
The massive placing of orders and the resulting mass-selling kind of push the rate away from the invisible line to which it approaches from below.
The support line, on the other hand, is seen by the traders as a level at which it is profitable to buy the currency for some reason; this is the reason why buying at the current market price occurs and why currency buy orders which were predefined by currency traders and are in the process of being executed by dealers get triggered.
Typically the orders are not placed at a single level, but rather at a specific price point forming a support or resistance area rather than a clear support or resistance level.
The placing of similar orders in the same areas occurs because different traders, using similar rules of technical analysis, calculate roughly the same level for selling and buying, which results in an inverse relationship between technical analysis methods and the nature of market moves.
(IS IT BETTER TO SELL AT THE SUPPORT LEVEL)
When prices break out of a sideways range or channel and break one of the lines (support or resistance) the move is usually accelerated. Therefore a buy signal occurs when prices break through the resistance line, and a sell signal when prices break through the support line. These signals may apply to both open and close positions.
Why does the movement accelerate?
As a rule, stop orders are placed outside the channel to close the positions of traders trading in it. Since the stop orders to close the positions of those who sold are “buy” orders when the course passes the zone of stop-orders concentration the movement begins to accelerate due to the mass execution of these orders to buy.
The same applies to the support area: as stop orders of those who bought it are concentrated and those stop orders are position closing orders, i.e. sell orders, the rate starts to fall downwards at an accelerated rate after breaking through the support area due to the mass sell order execution.
It appears that such zones due to the massive accumulation of orders change the balance of supply and demand for a short time, causing an acceleration of price movement. It is believed that large market makers sometimes use this feature of the market. By making large investments they bring the rate to the stop order accumulation area so that the market continues to move on its own.
Examples of popular strategies which use levels:
- Level breakout - you need to find important levels, wait for the breakout moment and then you can start trading.
- Trading in a channel based on levels - first you draw a channel (its borders are support levels below and resistance levels above), and then trade based on these values.
- Trading on a pullback - the price is in a trend, but the trading takes place when the price reaches the support level.
- There on a pullback - the price is in a trend, but the trading takes place when the price reaches the support level.
There are many such strategies and even if a trader does not use them, it is essential to know what the support and resistance levels are, as they are the base.
How do you calculate support and resistance?
Construction of support and resistance lines
On the EUR/USD weekly chart, each new minimum is higher than the previous one. If we connect them, we will get the support line. This is the line from which price bounces back in a trending movement. Likewise, in a downtrend, we will see a resistance line.
An important rule for drawing the support and resistance lines: each line should pass through at least two extrema.
If a currency pair is rising/decreasing steadily, it is wise to buy/sell without waiting for the support/resistance level to be reached. In this case, be guided by the support/resistance line.
All technical analysis patterns (triangles, flags, pennants, etc.) are thought to be just combinations of support and resistance levels.
What happens when support and resistance meet?
It is very common for a price level that used to be a resistance level to later become a support level. It is also not uncommon for the opposite situation to occur - a change from support to resistance. This can be explained by psychological reasons as well as by the properties of the prices themselves.
Psychologically speaking, the change from resistance lines to support lines and vice versa can be explained by people´s habit of paying a certain significant price, which is, in any case, a certain indicator of their attitude to the commodity.
From a pricing perspective, resistance and support lines play an important role in determining certain price levels at which market participants are willing to transact and move beyond which can only be triggered by significant changes in market participants´ attitudes to the commodity.
Such changes usually occur only under the influence of new information entering the market or are explained by purely psychological reasons (for example, the weakness of one of the parties). Although, sometimes market makers, who see a lot of market orders at certain prices, can stimulate the market to withdraw from the accumulation of such orders.
Which time frame is best for support and resistance?
We have understood how the trend is changing, now we need to decide on which timeframe to trade.
A timeframe is the interval of time used to group prices when constructing price chart elements.
This is how long it takes for the candles to form on the chart in simple human words.
If we choose 4 hours, we will get 6 candlesticks during the day. If we choose 1 hour, we will get 24 candlesticks per day, and so on.
In total there are 6 periods:
- M - minute (1m is one minute period)
- H - hour (4h - four-hour period)
- D - day (daily period)
- W - week
- Y - year (Y or 1Y - annual period)
The smaller is the period, the more noise and false breakdown/movements on the chart. For scalping, 1m-5m-10m minute timeframes are used, for the medium term 1h-4h-1d, for position trading D-W-M.
Multiframe analysis is trading using several timeframes, which allows you to enter the trade more accurately. For example, you build support and resistance levels on 4h, but you already look at the breakdown on 1h, as a result, your entry can be 4 times more accurate.
The most important thing is to understand that if you trade on 4h you don´t care what happens on the minute timeframes, if it goes down then let it go down, you only care about your working timeframe.