Support and Resistance Levels In Trading
Using support and resistance levels in technical analysis is one of the most important elements and a very common approach in the forex market. It is the basis for so many trading strategies, and a very essential tool for every trader who wants to learn how to apply good technical analysis. In addition to the simple form, there are different variations, some a bit more complicated. Eventually almost any experienced trader find the way to use support and resistance points in his trading. But first, you need to understand the idea behind these price levels. If you are new to trading it might sound a bit complex, but it’s actually not at all. In this article I try to clarify these concepts with a brief explanation of what you really need to know about support and resistance levels.
Support and Resistance Levels Explanation
Supports and resistance act as “barriers”. They prevent the price from proceeding to a certain direction. They are defined by historical data of the currency pair, or any other traded asset. Supports and resistances are actually psychological levels that reflects behavior of people who participate in the market. When traders approach their trading platform they analyze it by observing charts and identifying price action fluctuations. When they recognize price levels where many investors bought a certain asset in the past, or sold it, they will most likely prefer to give their “support” or join the “resistance” at the same level. This behavior tends to repeat itself and there are several reasons for that. There might be some big institutions that according to their investment policy it pays to buy a certain asset at this price. It might be a consensus among traders worldwide, that at a certain level of an asset it is over priced. And very often this is just a “self-fulfilling prophecy”. Eventually we are all using the same charts where we get our conclusions. So when we recognize a price pattern we know that so many others see it as well and are likely to act accordingly. Anyway, the truth is that it doesn’t really matter what is the reason. What does matter is that it works. And it will tend to work till proven otherwise.
When traders see that the price is testing a support, they expect it to rise. When they see a price hitting a resistance level they expect it to fall. These expectations often causes actions that create those levels and strengthen them.
What determine whether support and resistance points will be broken is the trading volume. Supports and resistances of any traded asset will break only in case there is a sufficient trading volume that is attached to the price action. If the volume is not sufficient there will not be a reversal. However it can still cause a pause for a while.
When support and resistance levels are being breached they usually change rules. If for example a resistance level is violated it means that there’s strong enough buying power that will probably push the price higher again in case that the price will fall back to that point. Same story on a support violation. So support become resistant and resistant become support once breached.
Support And Resistance Levels During Trend And Trading Range
Resistances and supports may take place in both trending or ranging markets. (See Forex Trends and Ranges). When the market is trending it’s less likely that they will cause a true reversal. However it’s very possible to see a stalling or a weakening of the trend. So when you recognize support and resistance levels during a trend, you better use them only for specifying entry and exit points. When you are buying, locate your profit targets slightly above resistances and stop losses slightly below support. and Vice versa. You can also use it to open new positions. For example when the market is up trending, you can wait to a downward correction and join the trend while buying when it reach the closest support, which use to be a resistance and has been already violated.
When the market is flatter, trading within a range, it can provide great Long and Short trading signals. When the price move toward the upper area of the range you can think to sell, while placing your stop-loss above the resistance level and profit target above the support. You should get a great risk reward ratio for such a trade. Same in the opposite case, where you might want to buy at the bottom of the range. Then use a stop-loss just below the support and a profit target below the resistance region.
To sum it up so far, support and resistance levels are a very important tool that if used properly can improve your trading decisions and results significantly. You can use them as an indication for entering a trade. However they are better used as trading signals during a consolidating market and even then i recommend you to use 1-2 additional indicators for confirmation. They are also very useful for your money management, as you can use it to define good stop-loss and profit targets.
In following articles i will talk about specific indicators that can be used as powerful support and resistance levels. So subscribe to my site and keep up to date!
And as always, if you have any question or comment don’t hesitate and comment or contact me. see you all later!