What is Support and Resistance in Forex?

The post What is Support and Resistance in Forex? by Jay and Julie Hawk appeared first on Benzinga. Visit Benzinga to get more great content like this.

If you’ve been exposed to the financial markets, then you may have noticed that the terms support and resistance seem to come up often in conversations among traders who use technical analysis. 

By scrutinizing exchange rate charts, technical forex traders can identify key demand points that suggest support in a market decline, as well as key supply points that suggest resistance to a market rally.

Going through this process helps technical forex traders determine optimal entry and exit points for their trades. Knowing about nearby support and resistance points in the market can also assist forex traders in placing their stop-loss and take-profit orders at safer levels.

In this article, Benzinga explains support and resistance levels, the various types and how to identify them, what support and resistance indicator options are available and how to use support and resistance to make profitable forex trades. 

What is Support?

Technical analysis teaches that the existence of support at a particular level or region from a preponderance of buyers and their orders can prevent a market from moving below that area because of the strong demand existing there.

A support level or region is the point or area appearing on an exchange rate chart that shows where the currency pair has attracted the buying interest that caused it to stop declining and consolidate or start to rise again after a decline. Support often shows up as a reversal to the upside seen after a series of drops. 

The forex market relies on supply and demand levels to determine exchange rates. If a currency pair’s exchange rate has been trending downward, the level where support arises is commonly known as a support level. This level would be where selling in the pair has been exhausted and buyers overtake sellers to push the exchange rate back up. 

What is Resistance?

Resistance is the opposite of support. Resistance is so named because it prevents a market from moving higher from the presence of sell orders that offer resistance to a rally continuing. 

Resistance levels generally consist of the exchange rate level or group of nearby levels that appear on an exchange rate chart to indicate where the currency pair has attracted selling interest. 

A resistance level occurs on a chart when a currency pair’s exchange rate has trouble breaking through a particular level to hit new highs. When the pair’s exchange rate nears or hits that resistance level, sellers take over the market and send the exchange rate heading back down again. 

Most resistance levels are situated at the reversal point where a market turns downwards after a rally.  Resistance levels thus typically appear when a market is rising, but keep in mind that they can also sometimes show up in a falling trend. 

Why Do Support and Resistance Levels Matter?

As any technical analyst will tell you, support and resistance levels definitely matter. Understanding support and resistance better so you can profit from observing them in practice can enhance your trading results considerably. You can see a schematic example of support and resistance levels in the image below. 

Diagram of resistance and support levels in an upwards movement. Source: BabyPips.com

By first identifying a currency pair’s key levels of nearby support and resistance, forex traders can better plan when to enter and when to exit positions in that pair. This practice can prevent losses and help make money.

As a case in point, consider a situation where a support level has been hit several times but the market has thus far not managed to fall below it. Future dips to that same support level can present a decent buying opportunity for an observant trader. 

A trader looking to profit from this scenario could open a long position near the support area with the objective of benefiting from yet another market bounce. They might place their stop-loss sell orders safely below the support zone. 

In an opposite scenario, a forex trader could open up a short position by selling a currency pair just below a known resistance level. This situation would allow them to profit from a downward exchange rate reversal originating near that resistance point. Buy stops would be placed safely above the resistance level. 

Knowing about major and minor support and resistance levels on a chart can also help when you want to get out of an existing position. For example, you can buy back shorts just ahead of support or sell out longs just before a resistance level. 

The chances of the market breaking through a major support or resistance point are substantially reduced. Knowing where those levels are can thus significantly improve your profit-taking strategy since you can choose better order levels that are more likely to be executed.  You can also use support and resistance levels to help reduce losses on losing positions. 

Keep in mind that support and resistance levels are not inviolable and can indeed be broken. When the forex market does breach an established support or resistance level, it often continues to move in the direction of the breakout toward the next level of that type. 

You can trade such breakouts to profit from the expected subsequent move. For example, you could open a short position when the market falls below its nearby support level or a long position when the market rises above its resistance level. You can then trade the following move looking to take profits just before the next support or resistance level. 

Furthermore, if a market is trading back and forward between its nearby support and resistance levels, then that is known as a ranging market, and the currency pair would be considered rangebound. Traders can profit from identifying this phenomenon by using range-trading strategies. 

Understanding Major vs. Minor Levels

Each support and resistance level is not equal to others in the degree to which the market will respect it. Support and resistance are sometimes further characterized as major or minor. 

In general, minor support and resistance levels will only briefly delay an overall trend of rising or falling exchange rates. In contrast, the appearance of major support and resistance levels could cause a trend to end and the market to reverse its direction completely. 

Support and resistance levels also become stronger the more times the market bounces off them. This phenomenon can turn a minor resistance level into a major one over time if it manages to rebuff repeated tests. 

The psychology of market participants also assists in forming and strengthening support or resistance levels. After a level is noted on the charts, orders are entered into the market by technical traders that can reinforce the importance of that level even more.

Also keep in mind that when the market breaks a major support or resistance level, then the resulting move in the direction of the breakout tends to be more significant than when a minor level breaks. 

In addition to categorizing support and resistance levels as major or minor chart points, you can also take into account the way in which these levels or regions are determined. The main chart point categories or types include: 

• Reversal point: The precise level where the market stops moving in the direction of the trend and starts going in the opposite direction. Major reversals appear as significant peaks and troughs on a chart, although they can also appear as the extreme of shorter-term reversals or corrections that commonly occur within a trend.
• Congestion area: A region where the market takes a break, usually before furthering its prior trend. Congestion can also occur when numerous reversals occur in the same narrow region.
• Broken levels: Broken support can turn into resistance, while broken resistance can turn into support, especially when the broken levels were considered to be of major significance. Traders who bought ahead of broken support might look to sell if the market rallies there again. Similarly, those who sold ahead of broken resistance could seek to buy ahead of it on retracements. 
• Psychological levels: Market psychology can react to round numbers in an exchange rate since these levels offer easy targets for long-term traders and hedgers to take action. Examples of major psychological levels would be 1.0000 in GBP/USD or 0.5000 in AUD/USD.
• Fibonacci retracement levels: When a trend is correcting, its Fibonacci retracement levels can initially impede the correction. When these retracement levels break, however, the corrective movement can then be furthered significantly. 
• Trend lines: When technical analysts can draw a clear trend line through a series of higher lows in an uptrend or a series of lower lows in a downtrend, then that line provides support where it lies at the present moment. Conversely, if a clear trend line can be drawn through a set of lower highs or higher highs, it provides resistance where it is currently situated.

Do Support and Resistance Levels Really Work in the Forex Market?

Support and resistance definitely work in the forex market. In fact, many professional currency traders look for and then use these levels to set their orders and signal trade entry points.

To make support and resistance work most efficiently for you when trading forex, you need to keep a close eye on the charts to spot developing minor support and resistance levels. You can also tabulate a series of major support and resistance levels around the current exchange rate for a currency pair you are considering trading.

Once you recognize a significant support level, you can use it as a profit-taking objective for short positions. You can similarly use resistance levels as a guide when liquidating long positions. Keep in mind that more recent chart points typically take precedence over older chart points of the same importance.

You can also trade support levels effectively by placing a bid just ahead of that support level. You enter your stop-loss sell order just below that support level. You then need to wait for the opening order level to trade.

This strategy lets you get a more advantageous exchange rate while running relatively low risk since your stop-loss level lies near your entry level. If your buy order is filled and the market then goes in your favor, you can move your stop up as the exchange rate rises using a trailing stop. You can either take profits at a chosen level or eventually get stopped out when the market reverses enough to trigger your stop. 

A nearby resistance level can also offer a useful guide for forex traders to short the market. They can then enter a protective buy-stop order safely above the resistance point.

Should You be Using Support and Resistance?

In most cases, forex traders should be aware of nearby major and minor support and resistance levels in any currency pair they intend to trade actively. These levels provide a useful roadmap of sorts that astute forex traders can use to help navigate the market more effectively and profitably. 

If you require additional training on forex trading or forex technical analysis, then be sure to check out Benzinga’s website for more expert information about your topics of interest. If you want to open up a margin account with a top online forex broker so that you can start trading currencies, then this Benzinga article compares 10 of the best forex brokers to help start off your search.   

Frequently Asked Questions

The post What is Support and Resistance in Forex? by Jay and Julie Hawk appeared first on Benzinga. Visit Benzinga to get more great content like this.