Welcome to Level 4!
If you made it this far, I think it is safe to say you are serious about becoming a legend of a trader.
Hats off to you!
Now, are you ready for another challenge?
In this level, we will get technical.
So put your big boy pants on and let’s get to it.
Have you heard the term support and resistance before?
Don’t worry if you haven’t! Here at HowToTrade Trading Academy, we want to make things easy for you to understand so we will take it step by step.
Okay, no more chit chat, let’s get to it.
Support and resistance are a valuable tool used by forex traders that help identify possible points on forex charts where price may change directions.
By studying these levels, forex traders can obtain a better understanding of what is going on in the forex market.
A picture, or in this case a zigzag pattern, paints a thousands words so let’s take a look at what this means in practice.
Support occurs when falling prices stop, change direction, and begin to rise. It is often viewed as a “floor” which is supporting, or holding up, prices.
Support levels indicate where there will be a surplus of buyers.
Resistance is a price level where rising prices stop, change direction, and begin to fall. It is often viewed as a “ceiling” keeping prices from rising higher.
Resistance levels indicate where there will be a surplus of sellers.
In their most basic sense, support levels denote prices that a currency will not likely fall below, while resistance levels indicate prices the currency will probably not exceed.
By analysing the support and resistance, forex traders can more accurately predict whether a current trend will keep going or, alternatively, reverse. Armed with this information, a trader can potentially find a price point to enter a position, or close a position, and place a stop or a limit.
But at this point, we may be getting ahead of ourselves.
We need to develop the foundation before we build the house, right?
First, let’s see how we can draw the support and resistance levels.
It is important to remember that support and resistance levels are not always exact numbers.
They are usually a zone covering a small range of prices so levels can be breached, or pierced, without necessarily being broken.
Throughout your journey as a forex trader, you will often come across a support or resistance level that appears broken, but soon after you’ll find out that the market was just testing it.
If you’re using candlestick charts, these “tests” of support and resistance are generally represented by the candlestick shadows.
Can you notice how the shadows of the candles tested the 1.4700 support level?
At those times it seemed like the market was “breaking” support.
Looking back, we can see that the market was only testing that level.
Unfortunately, there is no definite answer to that 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 look at the same example from above and see what happened when the price actually closed past the 1.4700 support level.
In our example, the price had closed below the 1.4700 support level but it ended up rising back up above it.
If you had believed that this was a real breakout and sold this pair, you wouldn’t have been happy.
Looking at the chart now, you can visually see and come to the conclusion that the support was not actually broken.
In fact, it is still very much intact and now even stronger.
To help you filter out these false breakouts, the trick is to think of support and resistance more of as “zones” rather than concrete numbers.
One way recommended by forex experts that helps traders find these zones is to plot support and resistance on a line chart rather than using 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 which can be distracting.
It’s like when someone is doing something really unreasonable, but when you ask them about it, they simply reply, “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.
But don’t worry, with a little practice, you’ll be able to spot potential forex support and resistance areas with one eye closed!