Support and resistance levels are the two most important concepts in technical analysis. It’s impossible to overstate their importance. Anyone who wants to be a successful trader must develop a thorough understanding of how these concepts work. Allow our forex brokers to explain.
What Are Support and Resistance Levels?
Markets can go up and down!
When the price of an instrument moves upwards, it is said to be appreciating, and when its price moves downwards, it is depreciating.
When the price of an instrument advances, it will eventually reach a level where enough buyers are not willing to pay any more for it. This level is called resistance.
When the price of an instrument declines, there will be a point where enough buyers are willing to buy it at a low price. This level is called support.
By now you know what forex trading is and how it works. Support and resistance in forex trading are levels where a price has a hard time breaking through them. It can be horizontal levels or diagonal levels. If a price bounces off these levels twice, it is considered strong support or resistance. In reverse, if a resistance level is broken, it becomes a new support level, and vice versa for support levels.
Support and resistance levels are price levels that signal an upcoming trend reversal or continuation once broken. They are great tools to spot strong trends and find entry and exit points for trades. If you are unfamiliar with this concept, open a demo trading account in fewer than 3 minutes for risk-free trading practise.
How to identify support and resistance levels
Support and resistance levels provide valuable insight into the trading psychology of significant players in the market. Identifying support and resistance levels is key to creating a trading strategy. That’s because these price points can be used as entry and exit points for trades. Plus, you can also use them to adjust your position sizes.
The basic idea is that these levels represent the highest probability of price reversals. However, it can be challenging to determine where these levels exist. There are no guidelines or rules that clearly state how to identify support and resistance levels on a chart.
Still, there are different methods of identifying support and resistance levels that can be used individually or together to increase your chances of success. These include;
Historical price data
The support and resistance levels are critical indicators of price trends; they are formed based on previous price movements by a certain percentage. The price action trader is interested in the most accurate support and resistance levels. Each level reflects the psychological price points, where many traders are ready to decide about buying or selling an asset.
Traders use historical price data to identify the chart’s current support and resistance levels. These levels are determined by finding historical highs and lows. Most traders who trade with these levels build their strategies around them and use them to identify good entry/exit points for their trades.
You can use many websites to find accurate historical price data. Use it wisely and make your trading profitable!
Note: These levels are not like hard boundaries that stock cannot cross, but they act like strong magnets.
Previous Support and Resistance level
One of the best ways to identify support and resistance levels is by looking at past prices. And the easiest way is by looking at old chart patterns.
Often, there will be a significant level that was once held as either support or resistance, but eventually broke. In this case, the broken level often becomes the new support or resistance level (depending on which way it was broken).
The most common form of support and resistance is the horizontal trendlines, aka the trendline. Trendlines are a favourite tool because you can use them for multiple purposes. When the market goes up, the trendline will be a rising line and vice versa for down movements.
A trendline connects the low points (for an uptrend) or high points (for downtrends) of an asset over time to identify current trends in its price movement.
These are a set of indicators developed by floor traders in the commodities markets to determine potential turning points, also known as “pivots.” Traders use pivot points to identify potential support and resistance areas for the current day’s session.
You can calculate pivot points for any time frame, but they are most often used in daily data with the preceding month’s data. Depending on where the market is heading, they act as both resistance and support.
The term ‘Fibonacci retracement’ might seem complex like ‘candlestick pattern’. However, they are not that complicated.
While traders generally use charts to identify trends, they also determine where a stock will stop falling (support levels) or rising (resistance levels).
The most common way to identify these levels is by using Fibonacci retracements. In technical analysis, this method assumes that a stock will retrace its original direction after making a sharp move either up or down.
Fibonacci retracements are produced by taking two extreme points of a price trend and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 61.8%, and 100%. Once you identify these levels, draw horizontal lines and use them to identify possible support and resistance levels.
Support levels are horizontal areas of price where a large amount of buying has occurred. On the other hand, resistance levels form when large amounts of selling occur and act as a horizontal line that prices cannot pass through. Support and resistance levels are chart patterns that tell us where to expect the market to attempt to go.
Identifying support and resistance levels is an essential part of analysing price charts, as they can help identify price patterns that one can use to build up a profitable trade. Read more about tips for beginners and make your trading profitable!
Get started with your Live FX Trading Account if you’re already familiar with forex trading.