Recently one of our members posed this question: What is support and resistance levels, is it important, and how is it applied to Forex trading?
I will start by saying absolutely, it is very important to understand support and resistance because these levels are the same levels that banks, large hedge funds, and other major players place their orders.
After we have our probable trade direction derived from the news and current sentiment, we then turn to the technical picture to isolate the best entry, target, and stop loss levels for our position. This is where it is essential to understand the concept of support and resistance. These are levels where a currency is expected to react because of supply or demand, or psychological factors.
So to put it simply, these are levels at which a lot of traders are willing to buy or sell a currency pair. If a pair is currently in a downtrend and we come into a level where there are a lot of buyers in the market, this level is called support. If a pair is in an uptrend and we come into a level where there are a lot of sellers, this is a level of resistance.
We can identify potential levels of support and resistance by analyzing past price action such as highs and lows, round numbers, the figure, trend lines, pivot points, and Fibonacci just to name a few.
Price support and resistance are levels where the market has proven in the past to have interest for buyer or sellers. These are previous highs and lows, and what we call shelves and ceilings.
In the example below notice how previous support turns into resistance after the level has been broken providing a level for sellers to enter into the market.
The same is true for key resistance once it is broken.
Fibonacci retracements and extensions are forms of measured support and resistance. Pivot points also fall into this measured category.
In the below example you can see how the market reacted at each pivot point level.
Fibonacci Retracements are one of the most widely used measured levels of support and resistance and are used to measure “pullbacks” of the current trend or swing.
Trend lines are unique because they take both price and time into consideration and project levels of support and resistance into the future.
The 00 levels also known as “the figure”, “big figure”, “the big fig”, or “the handle” are key psychological levels that the market often targets and reacts to.
Support and resistance levels are not only great for entering into the market, these are also levels you want to use to place your targets and protect your stop losses.
Lastly, the best way to use support and resistance levels is to locate a “confluence” area where multiple levels meet. This will increase the probability that the market will respect and react to that level.
In this example we can see how the trend line and Fibonacci levels met at the same levels to offer very nice buy opportunities on the pullbacks as the trend continued higher
So hopefully this post has helped you understand a little better how you can use support and resistance when trying to trade in line with the fundamentals, and I really want to encourage any other questions you have about trading strategies, so please put your questions and comments below so that I can understand exactly what strategies you would like to know more about!