When it comes to technical analysis, there are few concepts that are as discussed – or important – as support and resistance. Since technical analysis is a must for successful forex trading, it goes without saying that anyone who aims to build a career in this fields will have to encounter and deal with support and resistance. In order to facilitate this, we are going to attempt to shed some light on this matter and focus on things that are absolutely essential. In other words, this article will try to explain the meaning of support and resistance, their importance as well as other key aspects of these two.
Support and Resistance 101: What are they?
First and foremost, do not be misled by the fact that support and resistance come in various forms; this subject matter is actually a lot simpler than it may seem at a first glance. For example, any experienced trader has realized that certain assets can only be pushed so far in a single direction, regardless of how hard they try to influence their price. If the price of an asset has some serious difficulties climbing past a certain point, and cannot seem to achieve this, then this may in fact be its resistance level. Or, if it cannot seem to fall below a certain price, we are talking about a support level. When analyzing charts, support and resistance levels are often referred to as a floor or a ceiling respectively, mostly because this is as far as prices will go. Also, do not take these things for granted, as support and resistance are not set in stone and will get breached – eventually. Rather, the support and resistance level of a certain asset can be moved in accordance with market conditions.
However, being able to identify when these support and resistance-related events are going to occur (or not going to occur) is what makes or breaks a forex (or any other kind of) trader. For instance, if a trader manages to correctly identify the support level of an asset, then they have also identified a perfect opportunity to acquire it at rock bottom prices, before they inevitably bounce back up, at which point they can be sold at a nice profit. The mechanics behind this process involves other traders who will eventually pick up on this opportunity and start buying as well, effectively driving the price up again. Of course, support and resistance being two opposite sides of the same coin, the reverse also applies on resistance level. In other words, correctly identifying the point where the price of a certain asset will cease to rise will put a trader in the most advantageous position to sell said assets off at maximum profit, before everyone else start losing money. The process is actually the same, except it works in the opposite direction.
Support and Resistance: Trends and Trendlines
Without going into financial trends, it should be said that they are related to an earlier point that was made in this text, about no support and resistance being set in stone. These barriers can and do change with time, and what directs those changes are general trends. This is why trends and trendlines are just as important as support and resistance, especially for rookies who have yet to get their bearing in the industry. As markets trend upwards, resistance levels become stronger as traders slow down, expecting the price to fall down towards previously established borders. This “plateau” effect can be discussed further at another time, but it involves prices standing relatively still or even dropping slightly, before a new resistance level is established, as the market stabilizes yet again. Needless to say, support levels work in the exact same manner, except the price in this process goes down, rather than up. As the actual price gets closer to the perceived support level, the trading gears up toward short positions, expecting the prices to recover in the near future. When applied to a chart, the line that signifies the price will peak either at the upside or a downside; connecting these peaks is how a trendline is formed, and it is used as a general indicator as to whether the price is expected to rise or fall. However, in spite of their objectivity and accuracy, the fact that the use of trendlines is so widespread these days can often lead to problems of its own, as people start relying on these things too much and leave their positions vulnerable to traders who can think outside the box.
Support and Resistance: The Magic of Round Numbers
This may be a purely psychological effect, but whenever the price of an asset hits a round number, it faces difficulties moving away from it. Statistically, most traders tend to buy or sell an asset once it reaches a round number, as if it is objectively valued and this tends to affect trading in a way that is similar to support and resistance, albeit far more subjective. The fact that people tend to place stop orders and target prices at $40 rather than $39 or $41 means that round numbers can be considered to be effective price stoppers. As this is not a result of an objective situation, it can be relied upon regardless of other trends, at least for a while. In other words, whenever the price of an asset approaches a round number, it will tend to stick around for a while before continuing the trend (or reversing it).
Support and Resistance Indicators
In their quest for finding a perfect tool for identifying exact support and resistance levels, traders have often turned to all sorts of solutions and means, although by far the most widely used means is the moving average. Since it is a line that always changes in response to the market events, it can be used to predict future trends, albeit with dubious success record. Finding the perfect time period is often regarded as the key issue, while the fact that this is a reactionary tool is often overlooked. Other instruments include the Fibonacci retracement and various mathematical formulas. If there was such a thing as a truly effective way of predicting support and resistance, people would have heard of it by now.