Do you need support and resistance in Forex trading? Support and Resistance are an integral part of technical analysis. They typically refer to an area where the price action is likely to pause and change the direction.
A support area has the potential to stop the falling prices. Traders expect the price of an instrument to recover from a support level. Similarly, a resistance area has the potential to stop the rising prices.
Traders expect the price of an instrument to fall from a resistance level. However, the support and resistance levels are not the absolute barriers. Therefore, they're often breached. As a result, you always need to carefully analyze these levels to carry out the trades.
Support and Resistance Forex
- Typically when the price breaks through a particular price area that was either identified as support or resistance, it will become the opposite of what it was before. So if the price was rising and it broke through a resistance area, that resistance area will act as a support area for the price. Conversely, if the price was falling and it broke through a support area, that support area will act as a resistance area for the future price movement. In essence, that's support and resistance Forex.
1. How It Works
Remember that a support or resistance Forex area that remains intact after several attempts to break is considered a stronger area than the area that's tested only a few times.
At this point, you may be thinking why do the prices stop and change the direction from these levels? A simple explanation for this would be that these areas represent the demand and supply in the market.
We know whenever the demand for a product is high it drags the price higher as well likewise when there is less demand the price also declines.
So to wrap up, whenever the price is near a support level you can consider the demand would likely increase. Conversely whenever the price is near the resistance the demand would likely decline.
There are different ways to trade using support and resistance levels. Many traders prefer to buy when the price comes to a support level. Or simply sell when it reaches to a resistance level.
Some traders also prefer to trade breakouts. That's when a support or resistance level is broken and they place their trades in the direction of the breakout.
2. Using Trend Lines to Draw S&R Levels
One of the simplest and widely used method to find support and resistance Forex levels is by visually analyzing the charts. Then use trend lines to connect multiple points that are held intact during a certain period.
The best practice to draw a trend line is to connect at least two points. Trend lines can draw support and resistance areas in any direction of the market; whether it's upwards, downwards, or even sideways.
In up trending or down trending markets, the trend lines are usually angled. While in the sideways market they are mostly horizontal.
Now that you understand what support and resistance are and how you can identify them lets now learn about their different types.
Types of Support and Resistance
- There is no plain guideline on the types of support and resistance Forex.
- But from a theoretical point of view, they can be split into two types.
- Static support and resistance
- Dynamic support and resistance
Let’s first discuss Static support and resistance.
1. Static Support and Resistance
Static, as the name suggests, are support and resistance Forex areas that don't move. They're visually identified by the specific price levels that the historical price action has shown them to be at.
These static levels are visually identified and plotted using trend lines. And are the main type that traders refer to when they talk about support and resistance.
To understand further, below is an example of the NZD/USD chart on which support and resistance areas are drawn using trend lines.
These levels are showing the price is trading between the support level of 0.6700 and a resistance level of 0.6940.
Take a closer look at the price action as when the price comes down to the support at 0.6700 the price bounces back up. Conversely, when the price reaches the resistance level the price pulls back.
So basically the support and resistance areas are kind of a battleground between the bulls and the bears or in other words they represent a delicate balance between the demand and supply.
You can use these levels to place your trades. For example when the price comes near the support line you can buy the pair and keep your stop-loss just below the support line.
Similarly, when the price goes near the resistance level you can sell the pair and keep the stop-loss just above the resistance line. Remember that these support and resistance levels are not the absolute barriers and can't always hold the advancing prices.
They're just the numbers and are regularly breached. When they're breached they create new support and resistance levels and this is how the markets work.
2. Dynamic Support and Resistance
Dynamic support and resistance Forex levels are the opposite of the static levels because these levels change with the price movement. They're not visually identified but plotted using mathematical formulas with the help of technical tools like Pivot Point, Moving Average, and so forth.
These levels change regularly. For instance, you can plot pivot point levels on any given day but the next day, these levels will change. Moving average levels are also the dynamic levels because they also constantly change with the formation of every candlestick.
To understand more about dynamic levels, let’s take a look at the NZD/USD chart below in which a simple moving average is plotted. Remember that when you plot moving average, and the price keeps below the moving average line, it indicates resistance and if the price keeps above the moving average line it indicates the resistance.
Like in our example, when the price was above the moving average line it was acting as a support area and the price continued to rise. But as soon as the price moved below the line it acted as resistance area and the price kept dropping as well.
Support and resistance Forex is just as important as trading stocks, options and/or Futures. It's the bread and butter of trading. As a result, learn how to find support and resistance and you'll be a good trader.