One of the simplest but also most important techniques in technical analysis of the forex market is the use of support and resistance. A support line or support level is a level where the price of a currency pair does not easily goes under. A resistance line or resistance level is a level where the price of a forex pair does not easily go above. (We apply technical analysis to the Forex market here, but in the same way in can be applied to individual stocks, indices, or commodities)
In this article we focus on support and resistance in technical analysis. We explain why support and resistance levels are important, how to recognize these levels and how to use support and resistance in your own forex strategy. If you develop an understanding of support and resistance, it will help you to better predict the Forex markets and obtain good returns on your forex investments.
How support and resistance work
The price of a Forex pair is determined by the decisions of all forex investors together. If most people expect the price of the EUR / USD to rise and base their trades on this (i.e. they will buy the currency pair), their expectation will automatically come true. How long the upwards price movement continues depends on what the market thinks: if most investors think it will stop at the 1.3200 level, they will start selling their positions when the price approaches the 1.3200 level. Due to the decreasing demand for the currency pair, the price increase comes to a halt at (or near) 1.3200. In that case we can say that 1.3200 is a resistance level.
It is not true that a price increase or decrease is always restrained by a support or resistance level. Sometimes the underlying economic factors are so strong that the support or resistance is not sustainable. In such cases, there is often a struggle around important price levels between the technical investors (who believe in the strength of support and resistance) and the fundamental investors (which base their investments on underlying factors). If the technical investors are “stronger”, the level persists. But if fundamental investors are stronger, something interesting happens.
Say for example, that the interest rate has been raised by the ECB, which gives a positive impulse to the Euro. The currency will appreciate against the US dollar until it reaches a resistance level. The economic impulse, however, is so strong that the resistance level does not hold. The price rises through the resistance line (a “break-out”) which is considered by technical traders as a rejection of the resistance level. Because so much underlying economic strength was needed for the upward break through the resistance, it is a sign for investors that the exchange rate could no longer be sustained below that level. And thus the resistance line changes into a support line: technical investors now believe the price will remain above this level.
This process of “testing” resistance and support lines occurs regularly. If the support or resistance level endures, the price generally bounces back to an earlier level. If the support or resistance is broken, it is usually a signal for a further increasing/decreasing price, support levels turn into resistance levels and vice versa. This principle is important to remember and recognize because it allows you to make very lucrative trades on the financial markets.
Calculating support and resistance
The key to success in the use of support and resistance is finding out where the market thinks the support and resistance levels are. The easiest way to do this is by looking at the forex chart and to recognize certain price levels where the exchange rate was unable to break through in the past. The more often a level is touched but not broken, the stronger the resistance or support. We explain it in more detail based on the chart below.
This is the 1-hour chart of the currency pair EUR / CHF. You can easily create similar charts with a broker like Markets.com, IG, or Plus500. You can go to the menu of the trading platform to add lines and technical indicators to the chart.
The graph shows how the 1.2987 level first acts as a support line and later turns into resistance line. At point S1 the level is tested, but was not able to breakthrough and the price bounces up again. At B2 the support level is tested again and this time it’s broken. The expectation is that the previous support level will now turn into a resistance. This appears to be true. Four times (R1. R2, R3 and R4), the prices reaches to this level, but each time it bounces back again. Thus, a strong resistance has formed.
A less reliable way to find support and resistance levels is using whole numbers. For example, 1.0000 is, for example, an interesting level for the USD / CAD. The logic behind this is that many traders prefer to set their stop losses or take profits at a whole number. There is however no reason to participate in this. Try to determine your entry and exit points exactly according to your expectations of the market, not because it is a nice, whole number.
A third way to find support or resistance levels is with the help of additional technical analysis. Three common methods are moving average (SMA or EMA), Fibonacci levels, and pivot points. Because these are quite extensive to explain and involve quite a bit of calculation, we will discuss each of these techniques in a separate article.
Forex strategy based on support and resistance
There are several ways to earn money based on support and resistance levels. A simple way is to use them to determine your exit points for a position. With the help of other technical or fundamental indicators you open a position. Then you determine a target price (and preferably also a stop loss) based on support and resistance. You basically assume the price of a currency pair to keep trading within a narrow “range” between a support and resistance line.
For example: You have opened a short position on EUR / USD and there appears to be a support level at 1.3350. The current exchange rate is 1.3414. You set your take profit at 1.3360. That way you ensure you will be out of the market at the moment the support level is going to be tested and still make a profit of 54 pips. Remember, it is not about trying to take every single pip. The important thing is that you benefit from major Forex movements, and that you’re trapped if the market is in doubt. You could also have placed your profit target exactly at 1.3350. But if the price then moves to one pip above the support level and then bounces back again, you might be missing your entire profit.
A second way to make money with support and resistance is by opening positions on the rebound of a Forex pair against a support or a resistance line. In the above example, you could take a long position in the EUR / USD after the price decline was interrupted by the support level at 1.3350. You wait for that purpose until the support is hit and the first positive candle opens and closes completely above the support level. At that moment you open a long position, speculating on the price bouncing back up again. You set your stop loss just below the support level at 1.3335 for example, so you can limit your losses if the support does not appear to be strong enough.
A third way to make money with support and resistance levels is to open a “breakout trade”. In a breakout strategy you use support and resistance levels to detect the breakout of a Forex pair from its range. We will further elaborate on this strategy in the article “Break-out trading strategy”.
Do you want to try and test the strategies from this article yourself? You can do so with the advanced trading software of Markets.com, IG, or Plus500. Their software allows you to easily identify support and resistance levels in the price charts and includes a wide range of other technical analysis tools. Visit our broker review section for extensive reviews of many good brokers.
This article is part of the “Forex technical analysis strategies for advanced traders” series. Continue reading the next article “Breakout trading strategy“