Lesson 19 – Support & Resistance in Forex Markets
When learning about technical analysis as a forex trader, two of the most important and most used terms will be ”support” and “resistance”
Simple, yet effective.
These ideas are fundamental to almost all consistently successful trading strategies and often are a big help when finding the entry and exit points for our trades.
It is common for new traders to underestimate the power of support and resistance levels when making their technical analysis.
Most beginner traders jump straight into fancy strategies, tactics and guru secrets before having considered the absolute basics like support, resistance and trend lines.
They start using supportive technical indicators as their main strategy, like bollinger bands or fibonacci levels as these are more advanced, and everyone wants the most advanced strategy to find their edge.
When they do this, you are trading without some of the cornerstone information about hte market that will strongly improve their profitability as traders. And the bonus is, its one of the simplest and most easy to understand technical indicators a forex trader will find.
However, like with most things in life. The key to getting good is mastering the basics and executing those basics well again, and again, and again.
Support in Forex Markets
So let’s begin with support. As the term suggests, support is a price point in the price action that will usually give the market some stability and acts a ‘support structure for the current price’.
In other words, it is holding/supporting the price up to where it currently is.
In theory, you’ll see that when a price falls down before a previous support level, it will more than likely rebound back up to where it was before.
Where do I Find a Support Line in Forex Markets?
When the market hits a new low trough, or when the price is frequently bouncing off of a price range when in a downtrend then this is what we would consider a support.
The support area becomes evident due to an increasing concentration of demand in the market. A support zone’s price makes the market more attractive to a new wave of buyers, more than it attracts sellers. Therefore, the demand rises and the price bounces back up a little.
So, with a market in a downtrend, we would expect for the downtrend to at least pause, bounce or reverse at these common support zones and price points.
Note: as with trend lines explained in the previous lesson in this course, the more often a support or resistance zone is tested, the stronger or more valid it is considered to be.
Resistance in Forex Markets
Resistance acts in the exact same way as the support does.
Just in reverse.
It acts as an upper ceiling that the price will find resistance at before breaking through and moving further upwards.
When the market reaches a resistance zone, we expect it to slow down, and/orpause, and/or potentially reverse into a downtrend as the supply concentrates and demand reduces due to the high price.
Where do I Find a Resistance Line in Forex Markets?
Resistance zones are foud when the price reaches a new peak and then bounces back. This is usually the first sign of a potential resistance point. As this signifies that the market was unable to break this price point and was met with resistance.
When the price action reaches such a zone, and repeatedly fails to break it, in other words, gets rejected over and over, then we consider this to be a fairly strong resistance zone.
Most successful traders operate on the assumption that each support and resistance zone will be more likely to hold rather than break. It would be advisable that you integrate this strategy as more often than not, this assumption is proven correct.
Breakouts from Support or Resistance
As you can see in the AUD/NZD chart above, the price can in fact move through or past a support or resistance zone.
This is called a breakout.
The price has broken out of this imaginary obstacle, thus ‘breakout;.
Old Floor, New Floor & Old Ceiling, New Ceiling
As the price action is always moving in forex markets, so are the support and resistance lines and zones. When the market makes new lows and highs, these become the new support and resistance zones.
The old floor becomes the new ceiling after a breakout (old support -> new resistance)
The old ceiling becomes the new floor after a breakout (old resistance -> new support)
Market Psychology, summing up support and resistance
Simple, human psychology places a huge role in market movements as we will go into later on in the course. In a way, techincal indicator and key price action levels such as support and resistance only exist because everyone expects them to exist.
Thus, this drives the according behavior on a worldwide scale.
The vast majority of people, banks, businesses, institutions and retail traders alike, will place their long trades at support levels and their short trades at resistance levels.
This is precisely why support and resistance levels seem so solid and become a self-fulfilling prophecy.
As traders, sadly we cannot see the future. We however all aim to see the future with the exact same recent historical information. Therefore, a very large amount of us will act in the same way as we are all dealt with the same information.
So you have many thousands of traders all anticipating future movements based on the recent market information, thus a market price is strongly driven by this dynamic. At least in the short term.
Here’s a short quote to flesh out the point by Benjamin Graham. Author of the intelligent investor and mentor to Warren Buffet.
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
And the same is true in forex markets. This is a cornerstone principle to keep in mind when you are trading the market yourself.
Other areas where this manifests as you will see when looking at the charts yourself are seemingly random resistance lines.
But if you look closely, you might find that these are where:
- You find round numbers in a market (e.g. EURUSD at 1.1100 or 1.2000)
- You find Moving average intersection points (commonly the 10, 50 and 200)
- You find Trend Lines (as covered in the previous lesson)
More on each of these later on in the course.