October 16, 2017
Support and resistance are the most crucial concepts in technical analysis. Simply said, a support price is a price where the market should have difficulty to fall below (i.e. it will find “support” on that price level), while a resistance price is a price where the market will have difficulty to break above (i.e. the market will find “resistance” on that price level).
The market will usually test the support and resistance lines a few times before breaking them. The more the market tests and bounces off the lines, the more important the support and resistance lines become. A break of either the support or resistance line is then followed by an extensive down or up move, as the stop orders become filled and the market gets saturated with buy and sell orders.
It’s also important to note that when a support breaks, it becomes a resistance in the future. Similarly, a break of the resistance will act as a support afterwards. Although support and resistance lines can be used on any currency pair and time frame, they become more important with longer time frames.
As pictures oftentimes best describe new concept, here is an example of support and resistance in the forex market.
On the chart above, point (1) shows a price level where the price made a swing low, and didn’t manage to extend its move downwards. Now, we can draw a horizontal support line which will give us clues in the future where the market might have difficulties to move lower. And that’s exactly what happened at point (2). The market respected the previous low, the support price, and bounced off from the support line. Point (3) shows a break of the support line – a break of the support is usually followed by an extensive down-move. The magic happens at point (3), where the previous support line now acts as a resistance line and rejects the price which tries to break above.
Trend lines are another basic tool in a trader’s technical toolbox. A trendline connects multiple lows or highs, and the line itself is then projected into the future. Traders use trendlines much like they do support and resistance lines, only the trendlines need not to be horizontal lines. It is expected that the price will bounce of the trendline, and the trendline becomes more important with each price-bounce off the trendline. A downward trendline is shown on the following chart.
As can be seen from the chart, the downward trendline on USD/CHF connects lower highs, from point (1) which is the beginning of the trendline, to point (4) where the trendline is broken. To draw a trendline like this, you need at least two lower highs (points (1) and (2)). The price bounces off the trendline at points (2) and (3), before it’s ultimately broken at point (4). As with support and resistance lines, the broken trendline which acted as resistance at points (2) and (3), will after the break act as a support line.
If we extend what we’ve said about trendlines by drawing a parallel line with the same angle as the initial trendline, we will have created a channel. Channels are another popular tool when it comes to a forex trader’s technical analysis, just like support and resistance or trendlines. Let’s see what a channel looks like.
By connecting the higher highs (points 1, 3, 5, 6 and 7) and higher lows (points 2 and 4) with two parallel trendlines, we’ve created a channel on EUR/USD. The price bounces off the upper and lower trendline of the channel until it finally breaks the lower trendline at point (8).
How to Trade Support and Resistance
Trading support and resistance lines, trendlines and channels are a popular trading strategy. However, this strategy is usually used in combination with other types of analysis, like fundamental to reveal ideal entry and exit points.
However, some traders do rely solely on support and resistance trading. The basic idea behind this is to trade the bounces off support and resistance lines, trendlines and channels. Let’s see how to enter trades based on support and resistance, trendlines and channels.
Test Your Knowledge: Support and Resistance
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What is support and resistance?
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Question 1 of 3
The more the market tests and bounces off the lines, the more important the support and resistance lines become.Correct
Question 2 of 3
When a support breaks, it becomes a resistance in the future.Correct
Question 3 of 3
Channels represent which of the following:Correct