Support and Resistance (S&R)
The primary task of a forex trader is to predict the correct price direction of a currency pair at a specified time interval. Technical analysts always seek to identify the support and resistance levels as they are important in planning entry and exit points of trades.
Support is the price level at which declining prices bounce off and start rising again. At this level, the buyers take control of the market from sellers. It is sometimes referred to as floor or base.
Resistance is just the opposite of support. It is the price level at which rising prices begins to decline; meaning that sellers take over the market from buyers.
Major S&R levels completely reverse the price while minor S&R levels temporarily delay the price movements within a larger trend.
When a trader goes long, he opens a buy position on the trading platform. This means that he is predicting that the price of the forex pair will go up. It is synonymous with buying a currency at a low exchange rate and selling it when the rates go higher.
When you want to short sell a currency pair on the trading platform, you simply open a sell position. It means that you are selling the forex pair at a higher price and later buying it back when the price drops.
Support and Resistance lines
Traders buy at the support and sell at the resistance. To identify the support and resistance, lines are drawn on the charts. Below are the popular types of support and resistance lines:
Horizontal S&R levels
These are horizontal lines drawn by joining one or more price points. To draw the line, find points at which the support or resistance is strong and draw the line to join the points. Depending on the market momentum, the trader can enter the market expecting a reversal at the S&R levels, or trade a breakout if it occurs.
Round number S&R levels
In the forex market, most traders place their stop loss or take profit level around ‘round numbers’. So, S&R is likely to occur around these levels as stop losses are triggered. Round number S&R draws the line at round-number price levels such as 1.20, 1.25, 1.30, etc.
Trend line S&R
Trend lines are drawn by joining two or more price points in a chart. In an uptrend, two or more lows are joined by a straight line; for a downtrend, two or more highs are joined by a straight line. Horizontal lines are not used.
Channels are trend lines that comprise two lines; a lower and an upper line. The upper trend line indicates the resistance while the lower line shows the support levels. An up channel with a positive slope is regarded as bullish while negatively sloped channels are bearish. To draw a channel, first, draw the trend line; either an uptrend or downtrend, then draw a parallel line and move it to touch the recent high for an uptrend or recent low for a downtrend.
Traders buy when prices touch the lower trend line and sell when prices touch the higher trend line.
Leonardo Fibonacci invented the infinite series of numbers: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55… The next number is obtained by adding the previous two numbers.
In the series, if you divide a number by the next number, you will approximately get the golden ratio. For example:
55/34 = 0.618
The golden ratio can be observed in nature, painting, music, etc. Fibonacci levels are deployed by traders to find potential retracement levels in established trends. The trader must first identify the trend direction and then use the Fibonacci tool to identify where the price corrections will end. The Fibonacci retracement tool is used to plot retracement lines on the charts in line with the Fibonacci sequence. The lines represent the estimated support and resistance levels expected from the market.
To apply the Fibonacci tool, do the following:
- Identify the first impulse movement of the trend. This is a strong price movement; whether it is upwards or downwards.
- Draw the Fibonacci tool from down to the top of the trend for an uptrend and do the opposite if it is a downtrend. This tool will draw horizontal lines which represent the retracement ratios. If the forex pair retraces from a high, it is likely to find support at one of the levels.
- The trader can then enter a position based on the retracement ratios and support level found.
Bear in mind that Fibonacci retracement may fail and the price will break through the levels. So, ensure that you have other tools and a trading plan to help you to increase your chances of getting winning trades.
Tips on drawing S&R lines
When drawing the lines, adhere to the following tips:
- Do not concentrate on old prices. When using high time frames such as monthly; do not use historical prices above 12 months.
- For shorter time frames, draw the trend line by joining the closing or opening prices; that is, use the body of the candlesticks. Do not use the wicks; which represent the highest and lowest prices within a time frame.
- If a support level is broken, it may become the new resistance level and vice versa.
- Understand the difference between S&R zone and S&R level. S&R zone is a range of prices or a zone where the price can retrace within it while S&R level is the level at which the price might reverse.
- When you use Fibonacci retracement tool, the S&R prices may not be exact at the drawn levels.
- Use multiple time frame analysis when identifying S&R.
Support and Resistance are important price levels at which the price direction reverses. Forex traders need to identify these levels and place their trades accordingly; buy at the support and sell at the resistance. To help with the identification of the S&R, the trader draws lines on the charts which can be horizontal, drawn at round numbers, or drawn as a trend line.
The Fibonacci tool adds horizontal lines to the chart representing retracement ratios. These lines can be used to identify the retracement levels for the forex pair. But, it is not 100% accurate.