Support and resistance levels provide forex traders with a valuable tool they can use in their trading. By learning about these levels, investors can obtain a better understanding of what is going on in the markets.
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 these key levels, investors 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.
At this point, we may be getting ahead of ourselves. To make things a little easier, let's start at the beginning. We need to develop the foundation before we build the house, right?
Support and resistance levels are a key component of technical analysis, a practical approach used by many traders.Technical analysts leverage charts and other tools to study market history and identify patterns that may help provide insight into future activity, although past performance is no guarantee of future results.
This method, which looks into the supply and demand surrounding a particular security or currency, is concerned with what actually happens, instead of seeking an explanation for why something happens. For example, a technical analyst would focus on the price of a currency, instead of what fundamental analysts believe it "should" be worth.
Technical analysis rests on a handful of basic assumptions, one being that history has a tendency to repeat itself.
Currencies tend to move in up trends, down trends or range. Trends may be short term or long term, but they will not keep going in one direction indefinitely, and they will frequently encounter either support or resistance.
Support And Resistance Levels
If a currency has difficulty falling below a certain price, it has reached a support level. Generally, this happens because a currency's drop in value has resulted in there being more buyers than sellers. At this point, traders sweep in and make purchases, creating a floor.
Alternatively, when a currency encounters difficulty rising above a specific value, it has hit resistance. This usually occurs because the number of sellers outweighs the number of buyers after a currency has experienced a sharp increase in price.
However, it is important to note that support and resistance levels are not always confirmed. For example, if a currency breaks past resistance, such a development can draw the interest of many investors, driving its price higher.
In contrast, other market participants may sit back and wait for the currency to lose some value, especially if it shot up in price upon surpassing resistance. In this case, the investors who hold back could be a new source of support.
If a currency falls below support, this development could help trigger a broader sell-off. Such situations may occur when a currency responds to major news on a political or economic development. In this case, the old support could become the new resistance as the currency struggles to reach its previous price range.
It is important to keep in mind that investor decisions are largely driven by psychology. As a result, the global markets will frequently create levels of support and resistance that are psychologically significant.
In the case of stocks, these levels frequently exist at round numbers. For example, a share of ABC Co. could have a hard time falling below US$50 and rising above US$100. However, currencies can be a bit more complicated, and the numbers that form both resistance and support may seem somewhat arbitrary.
Therefore, it can help to conceptualise currency support and resistance levels in terms of ranges.
The Importance Of Support And Resistance
Support and resistance are important tools that almost every technical analyst will use. By taking the time to identify these crucial levels, investors can identify ranges that currencies are trading in and make better-informed transactions.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…