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Forex Education

Support and Resistance Levels

https://www.forextradingrobotea.com

To start your education on technical analysis, let’s begin with the basics: support and resistance!

Forex Support and Resistance

Support and resistance is one of the most widely used concepts in forex trading.

Strangely enough, everyone seems to have their own idea on how you should measure forex support and resistance.

Let’s take a look at the basics first.

Forex Support and Resistance Explained

Look at the diagram above. As you can see, this zigzag pattern is making its way up (bull market). When the forex market moves up and then pulls back, the highest point reached before it pulled back is now resistance.

As the market continues up again, the lowest point reached before it started back is now support.

In this way, resistance and support are continually formed as the forex market oscillates over time. The reverse is true for the downtrend.

Plotting Forex Support and Resistance

One thing to remember is that support and resistance levels are not exact numbers. Often times you will see a support or resistance level that appears broken, but soon after find out that the market was just testing it.

With candlestick charts, these “tests” of support and resistance are usually represented by the candlestick shadows.

Forex Support and Resistance | Support holding at 1.4700

Notice how the shadows of the candles tested the 1.4700 support level.

At those times it seemed like the market was “breaking” support.

In hindsight, we can see that the market was merely testing that level.

So how do we truly know if support and resistance was broken?

There is no definite answer to this question. Some argue that a support or resistance level is broken if the market can actually close past that level. However, you will find that this is not always the case.

Let’s take our same example from above and see what happened when the price actually closed past the 1.4700 support level.

Forex Support and Resistance | Support holds at 1.4700

In this case, the price had closed below the 1.4700 support level but ended up rising back up above it.

If you had believed that this was a real breakout and sold this pair, you would’ve been seriously hurtin’!

Looking at the chart now, you can visually see and come to the conclusion that the support was not actually broken; it is still very much intact and now even stronger.

To help you filter out these false breakouts, you should think of support and resistance more of as “zones” rather than concrete numbers.

One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart. The reason is that line charts only show you the closing price while candlesticks add the extreme highs and lows to the picture.

These highs and lows can be misleading because often times they are just the “knee-jerk” reactions of the market.

It’s like when someone is doing something really strange, but when asked about it, he or she simply replies, “Sorry, it’s just a reflex.”

When plotting support and resistance, you don’t want the reflexes of the market. You only want to plot its intentional movements.

Looking at the line chart, you want to plot your support and resistance lines around areas where you can see the price forming several peaks or valleys.

Line chart showing forex support and resistance zones

Other interesting tidbits about forex support and resistance:

  • When the price passes through resistance, that resistance could potentially become support.
  • The more often price tests a level of resistance or support without breaking it, the stronger the area of resistance or support is.
  • When a support or resistance level breaks, the strength of the follow-through move depends on how strongly the broken support or resistance had been holding.
Examples of forex support and resistance

With a little practice, you’ll be able to spot potential forex support and resistance areas easily.

Bounce off Support

Trend Lines

Trend lines are probably the most common form of technical analysis in forex trading.

They are probably one of the most underutilized ones as well.

If drawn correctly, they can be as accurate as any other method. Unfortunately, most forex traders don’t draw them correctly or try to make the line fit the market instead of the other way around.

Trend Line Example

In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys).

In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).

How do you draw trend lines?

To draw forex trend lines properly, all you have to do is locate two major tops or bottoms and connect them.

What’s next?

Nothing.

Uhh, is that it?

Yep, it’s that simple.

Here are trend lines in action! Look at those waves!

Forex trend line examples: uptrends, downtrends, and sideways trends

Types of Trends

There are three types of trends:

  1. Uptrend (higher lows)
  2. Downtrend (lower highs)
  3. Sideways trends (ranging)

Here are some important things to remember using trend lines in forex trading:

It takes at least two tops or bottoms to draw a valid trend line but it takes THREE to confirm a trend line.

The STEEPER the trend line you draw, the less reliable it is going to be and the more likely it will break.

Like horizontal support and resistance levels, trend lines become stronger the more times they are tested.

And most importantly, DO NOT EVER draw trend lines by forcing them to fit the market. If they do not fit right, then that trend line isn’t a valid one!

Channels

If we take this trend line theory one step further and draw a parallel line at the same angle of the uptrend or downtrend, we will have created a channel.

No, we’re not talking about ESPN, National Geographic Channel or Cartoon Network. Still, this doesn’t mean that you should walk away like it’s a commercial break- channels can be just as exciting to watch as Game of Thrones or Keeping Up with the Kardashians!

Channels are just another tool in technical analysis which can be used to determine good places to buy or sell.

Both the tops and bottoms of channels represent potential areas of support or resistance.

Forex channel examples: up, down, and sideways channels

To create an up (ascending) channel, simply draw a parallel line at the same angle as an uptrend line and then move that line to position where it touches the most recent peak. This should be done at the same time you create the trend line.To create a down (descending) channel, simply draw a parallel line at the same angle as the downtrend line and then move that line to a position where it touches the most recent valley. This should be done at the same time you create the trend line.

When prices hit the LOWER trend line, this may be used as a buying area.

When prices hit the UPPER trend line, this may be used as a selling area.

Types of channels

There are three types of channels:

  1. Ascending channel (higher highs and higher lows)
  2. Descending channel (lower highs and lower lows)
  3. Horizontal channel (ranging)

Important things to remember about drawing trend lines:

When constructing a channel, both trend lines must be parallel to each other.

Generally, the bottom of channel is considered a buy zone while the top of channel is considered a sell zone.

Like in drawing trend lines, DO NOT EVER force the price to the channels that you draw!

A channel boundary that is sloping at one angle while the corresponding channel boundary is sloping at another is not correct and could lead to bad trades.

How to Trade Support and Resistance

Now that you know the basics, it’s time to apply these basic but extremely useful technical tools in your trading.

Because here at BabyPips.com we want to make things easy to understand, we have divided how to trade support and resistance levels into two simple ideas: the Bounce and the Break.

The Bounce

As the name suggests, one method of trading support and resistance levels is right after the bounce.

Many retail forex traders make the error of setting their orders directly on support and resistance levels and then just waiting to for their trade to materialize.

Sure, this may work at times but this kind of trading method assumes that a support or resistance level will hold without price actually getting there yet. You might be thinking, “Why don’t I just set an entry order right on the line? That way, I am assured the best possible price.”

When playing the bounce, we want to tilt the odds in our favor and find some sort of confirmation that the support or resistance will hold.

For example, instead of simply buying right off the bat, we want to wait for it to bounce first before entering.

Bounce of support | How to trade support and resistance in forex

If you’ve been looking to go short, you want to wait for it bounce off resistance before entering.

Bounce of trend line | How to trade support and resistance in forex

By doing this, you avoid those moments where price moves fast and break through support and resistance levels. From experience, catching a falling knife when trading forex can get really bloody!

The Break

In a perfect world, support and resistance levels would hold forever, McDonald’s would be healthy, and we’d all have jetpacks. In a perfect forex trading world, we could just jump in and out whenever price hits those major support and resistance levels and earn loads of money.

The fact of the matter is that these levels break… often.

So, it’s not enough to just play bounces. You should also know what to do whenever support and resistance levels give way!

There are two ways to play breaks in forex trading: the aggressive way or the conservative way.

The Aggressive Way

Aggressive Trade

The simplest way to play breakouts is to buy or sell whenever price passes convincingly through a support or resistance zone.

The key word here is convincing because we only want to enter when price passes through a significant support or resistance level with ease.

We want the support or resistance area to act as if it just received a Chuck Norris karate chop: We want it to wilt over in pain as price breaks right through it.

Aggressive way of trading a break of support or resistance

The Conservative Way

Conservative Trade

Imagine this hypothetical situation: you decided to go long EUR/USD hoping it would rise after bouncing from a support level.

Soon after, support breaks and you are now holding on to a losing position, with your account balance slowly falling.

Do you…

A. Accept defeat, get the heck out, and liquidate your position?

or

B. Hold on to your trade and hope price rises up again?

If your choice is the second one, then you will easily understand this type of forex trading method.

Remember, whenever you close out a position, you take the opposite side of the trade.

Closing your EUR/USD long trade at or near breakeven means you will have to short the EUR/USD by the same amount.

Now, if enough selling and liquidation of losing positions happens at the broken support level, price will reverse and start falling again.

This phenomenon is the main reason why broken support levels become resistance whenever they break.

As you would’ve guessed, taking advantage of this phenomenon is all about being patient.

Instead of entering right on the break, wait for price to make a “pullback” to the broken support or resistance level and enter after the price bounces.

The conservative way of trading breaks of support and resistance: Wait for the pullback

A few words of caution… IN FOREX, THIS DOES NOT HAPPEN ALL THE TIME. “RETESTS” OF BROKEN SUPPORT AND RESISTANCE LEVELS DO NOT HAPPEN ALL THE TIME. THERE WILL BE TIMES THAT PRICE WILL JUST MOVE IN ONE DIRECTION AND LEAVE YOU BEHIND. BECAUSE OF THIS, ALWAYS USE STOP LOSS ORDERS AND NEVER EVER HOLD ON TO A TRADE JUST BECAUSE OF HOPE.

Summary: Trading Support and Resistance

When the market moves up and then pulls back, the highest point reached before it pulls back is now resistance.

As the market continues up again, the lowest point reached before it climbs back up is now support. One thing to remember is that horizontal support and resistance levels are not exact numbers.

To help you filter out these false breakouts, you should think of support and resistance more of as “zones” rather than concrete numbers.

One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart. Another thing to remember is that when price passes through a resistance level, that resistance could potentially become support.

The same could also happen with a support level. If a support level is broken, it could potentially become a resistance level

Forex Support and Resistance

Trend Lines

In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys).

In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).

There are three types of trends:

  1. Uptrend (higher lows)
  2. Downtrend (lower highs)
  3. Sideways trends (ranging)

Channels

To create an up (ascending) channel, simply draw a parallel line at the same angle as an uptrend line and then move that line to a position where it touches the most recent peak.

To create a down (descending) channel, simply draw a parallel line at the same angle as the downtrend line and then move that line to a position where it touches the most recent valley.

  1. Ascending channel (higher highs and higher lows)
  2. Descending channel (lower highers and lower lows)
  3. Horizontal channel (ranging)

Trading support and resistance levels can be divided into two methods: the bounce and the break.

When trading the bounce we want to tilt the odds in our favor and find some sort of confirmation that the support or resistance will hold.

Instead of simply buying or selling right off the bat, wait for it to bounce first before entering.

By doing this, you avoid those moments where price moves so fast that it slices through support and resistance levels like a knife slicing through warm butter.

As for trading the break, there is the aggressive way and there is the conservative way.

In the aggressive way, you simply buy or sell whenever the price passes through a support or resistance zone with ease.

In the conservative way, you wait for price to make a “pullback” to the broken support or resistance level and enter after price bounces.

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