How To Analyze Support And Resistance In Forex Trading
Support and Resistance In Forex Trading
The concept of support and resistance are very vital for a successful Forex trading. Every thing done in the Forex business revolves round support and resistance. Knowing how to analyze support and resistance will make you a better trader. In this tutorial, we will teach you how to analyze and trade support and resistance. We will look at the following sub topics:
* Meaning of Support in Forex?
* Types of support with examples
* How to draw support trend line
* Meaning of Resistance in Forex?
* Types of Resistance with examples
* Valid support and resistance
* Characteristics of strong support and resistance
* How to Analyze and trade support and resistance
* Examples Of Trading Support and Resistance
What is Support in Forex?
A support is a price level or area on your chart that has potential to cause a rise in price. A support level/area has tendency to make a falling price to reverse temporarily or permanently.
Types of Support
There are three main types of Support namely:
* Horizontal Support
* Trend line support and
* Dynamic Support
Horizontal Support
Horizontal Support is commonly used by Forex traders. Horizontal support is identified by looking at past price action to see where falling price was halted and began to rise. Once identified, use the horizontal line tool to mark it into the future. The tendency is that when next price comes there, it could reverse. In drawing horizontal support, you need at least one point to do so. The chart below is an example of horizontal support:
Figure-2 Support As Price Area on your chartIn figure-2 above, we have shown the whole area of support. It is better to see support as an area. This will help you know when it has actually been violated or broken and when it is still intact. The body of the candles and the tails/shadows gives us the whole area of support. In ruling support for purpose of trading, always include the whole area for better analysis.
Trend Line Support
Trend line support is also called diagonal or slanting Support. Trend line support is a type of support identified with the help of trend line tool. As price makes higher high and higher low swings in an uptrend, trend line tool is used to connect the higher lows to depict future area of support. Shown below is an example of trend line support:
Figure-3 Trend Line SupportObserve how price touches and bounces back up each time it approaches the trend line indicating area of support.
How to draw support trend line
To draw support trend line, you need at least two price points. Trend line support lines need to have at least two price-point to be drawn. Simply connect two swing lows(a low and higher low) in a price-chart with a trend line, and project the trend line into the future. However, bear in mind that the line become more important if the price touches them at least three times.
Dynamic Support
Dynamic support levels change their level with each new price-tick. Moving averages provide dynamic support at various areas of the market. Common moving averages used are the 200, 100, 50 and 21 exponential moving averages. Below is example chart showing dynamic support by moving average:
Figure-4 Dynamic SupportFigure-4 shows two moving averages acting as dynamic support. Each time price comes back to the moving averages, price quickly rally up to a new high and the trend kept going up. To Learn more about moving averages and how to use them, read How to effectively use moving averages in Forex trading.
What is Resistance in Forex?
A resistance is a price level or area on your chart that has potential to cause a fall in price. A resistance level/area has tendency to make a rising price to reverse temporarily or permanently. Resistance area is one which has posed obstacle to a rising price such that price began to fall. What causes the fall is when sell orders become more than buy orders creating an imbalance and subsequent fall in price.
Types of resistance
There are three main types of resistance namely:
* Horizontal Resistance
* Diagonal or slanting resistance and
* Dynamic Resistance
Horizontal Resistance
Horizontal Resistance is commonly used by Forex traders. Horizontal resistance is identified by looking at past price action to see where rising price was halted and a fall began. Once identified, use the horizontal line tool to mark it into the future. The tendency is that when next price comes there it could reverse. In drawing horizontal resistance, you need at least one point to do so. The chart below is an example of horizontal resistance:
Figure-5 Horizontal ResistanceIn figure-3 above, we can see a horizontal resistance lines placed where resistance to rising price has occurred previously. The idea for placing the line is to keep yourself on the know of where possible future resistance and sell trade opportunity might happen in the future.
Trend Line Resistance
This is also called Diagonal or slanting resistance. This kind of resistance is drawn by trend line tool. The trend line drawn is a down sloping line. The down sloping line indicates area of resistance. The trend line tool can be used to highlight a down trending market. Let’s see example chart below:
Figure-6 Trend Line ResistanceFigure-4 above is an example down trend identified and marked by a trend line tool. Notice how each time price rises back to the trend line, sellers would jump in and push the price lower.
How to draw Trend line Resistance
To draw resistance trend line, you need at least two price points to do so. Trend line resistance lines need to have at least two price-point to be drawn. Simply connect two swing highs(a high and lower high) in a price-chart with a trend line, and project the trend line into the future. However, bear in mind that the line become more important if the price touches them at least three times.
Dynamic Resistance
Dynamic resistance levels change their level with each new price-tick. Moving averages provide dynamic resistance at various areas of the market. Common moving averages used are the 200, 100, 50 and 21 exponential moving averages. Below is example chart showing dynamic resistance by moving average:
Figure-7 Dynamic ResistanceNotice how price was respecting the 21 exponential moving average resulting to a fall in price.
Valid support and Resistance
A support area or level becomes valid and important when it has been tested two or more times without being broken. In the same manner, a resistance area or level becomes valid and important when tested two or more times without being broken. However, some support and resistance are more valid and important than the others. Not all support and resistance are created equal. Valid support and resistance as measured by their authenticity and potentials.
General Features of Support and Resistance
1. Higher time frame support and resistance are more visible and as such tend to make more impact than the shorter time frame ones. eg. 4hr, daily, and weekly support and resistance.
2. When lower time frame support and resistance lean on higher time frame levels, they tend to be strong.
3. Broken support can act as resistance in the future.
4. Broke resistance can become support in the future.
5. Recent support and resistance tend to be more important than old ones.
6. Support and resistance act more like price zones/areas than price levels.
Characteristics of strong support and resistance
* It has lasted longer without being broken.
* It has been tested more times
* It has moved a considerably long distance — The distance covered on its test shows the extent of rejection from the level/area
* Time involved – time taken by price to return to the area tell of more of its value-The longer the time the better. If price returns to it faster and more frequently, the likelihood of its break is more.
How To Analyze Support and Resistance
Monitor price closely as it approaches support and resistance for clue as to whether the level is likely to hold or break. Strong momentum breakout that closes outside the level/area will signify a high likelihood of a continuation when price retraces back to the broken level. A strong price rejection around the key level will provide confirmation on the strength of the key level and the higher likelihood of it holding.
I have explained below the things professional traders do when analyzing or Evaluating support and resistance.
Previous Price action at that support or Resistance Area/level
* How did price react to those levels in the past? Very strongly by approaching it one time, then reverse sharply off of it? If so, then it’s very likely the next time it approaches that level, traders will place orders around there expecting a similar reaction.
* How significant is it (lower time frame, higher time frame)- How far did price move away from the support or resistance area? The distance or height moved by price from the level tells us the extent of rejection from the level.
* Did the level produce a breakout pullback setup? What this means is whether the level has held severally and then was broken and after the break, there is a pullback to it and it held again returning price movement to the trend breakout direction. If so, it is a sign of strength to the level.
* How long did it hold. This means how long it held price from breaking through the area or level. The emphasis is in the length of time price struggled to break the area/level without success leading to price changing direction or before breaking through it. Experience shows that when price struggles for long on a support area and eventually price change direction and climb up, if price returns to that area soon, it often holds. The reverse is the case for a resistance area. Similarly, if price after struggling at support area for long, and eventually it is broken, when price soon returns to the breakout area, it often change role and act as resistance. The reverse is the case for a resistance area.
* Is the support or resistance area visible in higher time frame charts like 4hr, daily, and weekly or is it only visible on 1hr chart or lower. Support and resistance in higher time frames are stronger than the ones in lower time frames. That goes to say that when higher time frame charts are trending up, lower time frame resistances are often broken to enable the trend continue. Similarly, when higher time frame charts are trending down, lower time frame support areas are often broken for the down trend to continue.
Current Price Action
This is all about the current market swing. Just because a level held nicely in the past doesn’t mean it will do same now. May be you’ve probably experienced this, expecting a level to hold only to watch it get broken. By learning to read the price action in real time, you can see if the market is approaching it with strength or weakness, impulsiveness or correctives, and then use this information to determine if a level will hold the oncoming assault forming a breakout or trend continuation.
key Price Levels
These are just areas where traders place orders, but if the defenses of those levels are weak, they will not withstand the attack, so it is crucial you are always watching price action in real time to determine if this will hold. Whether or not the support or resistance is key, consider waiting for price action trigger before you trade. If the market is approaching it with several signs of strength, then consider waiting for the level to hold before placing order. Price action trigger can sometimes differ from a level holding. That a key level held in the past, does not mean it will hold the next time the market comes to it. The strength or impulsiveness with which price is heading to it to a large extent determines whether it will hold or not.
Number of touches
Two touches or a bounce from the level/area is a good sign it is likely to hold the next time price comes back to it. From experience it usually gets to a maximum of 4 touches before the market successfully breaks the level. However once it does, that level often provides a strong opposite ie support turned resistance and vice versa
Confluence
You Can use things like Fibonacci, trend lines etc to support an argument for a level .
Price action behavior into the level
How price is approaching the area/level of support or resistance matters. For example you are waiting to buy at support but the size or momentum of bearish candlesticks approaching the area is large with little or no rejections at their low prices. Because of the huge selling that is coming into the support area, you may not want to buy any bounce or price rejection at that level but rather wait for further price action for more conviction. You may now want to wait for a consolidation and breakout to take your trade and when there is no consolidation you avoid the trade and wait for another opportunity.
Relevancy
How important is the level most recently? If there is a strong support and resistance level but on the most recent movements the area has had no respect (the market has traded up and down through it without impact) then it may not be a strong level any more.
Market Structure
Finding out the context of the market is key to successful trading. You must not trade every support and resistance. What is the market currently doing – trending, sideways, forming flags/wedges etc and if you were to take a trade where would you place stops and is there a chance that others will place stops in the same area.
Nearby Support and Resistance
Be aware that while you might have a strong S/R level, if there is another level close-by that has a support/resistance argument, you will often find the bigger institutions squeeze down to that level in an effort to trap traders who are playing both a break of the stronger level (and who in the process of doing so put their stops immediately above the high/low of that breakout trade), and also those who may be playing for a fail. If you have ever seen a strong level get broken, a bounce at an area that seemed to have insignificant support/resistance in comparison and the immediate run back with a failed break then you know people got played for their liquidity for a larger institution/s.
Trading Support And Resistance
I think we have done sufficient theories on this topic. Now let’s consider a few practical examples of how you can trade support or resistance of real live Forex chart.
Figure-8 Support And Resistance Trading-example-oneIn the chart above, we have an uptrend 4hr EURUSD chart. After a good swing up from key support, price took quit longer time to come back to the key support area. On reaching there, we observed several hours of consolidation above the support with eventual upwards breakout giving us buy-1 entry. The entry signal is the strong bullish engulfing candle that broke and closed above the consolidation also piercing the moving average. Buy-2 setup entry is a pullback entry. Notice that the previous resistance was broken and as price came back to the level, that level changed to support helping price to continue up. Buy-3 is failure break buy trade. Sellers pushed price below support and could not move further. Several hours of consolidation and an upwards break. Putting trendline on the price action that moved below the horizontal support, it gives us a descending channel which was also broken after the consolidation. Sell-1 and sell-2 are all counter trend sell trades which is not advisable for newbies.
Let’s see another example below:
Figure-9 Trading Support and ResistanceAt the 1st test of support, buyers came in and made a directional movement up to the moving average. Sellers took over but were not as strong as the 1st buy impression. Sellers were not allowed to make another lower low before buyers came in again and broke the trend line but could not make higher high. Then sellers took over again thinking that this time around we are going to succeed as they pierced the horizontal support the 2nd time buyers rejected them. The bullish engulfing candle is the full confirmation of sellers rejection at the recent support and forms the buy entry signal. Okay let look at the final example:
Figure-10 Trading Support and ResistanceThe above sell trades are all pullback trade setups in a down trend. Notice where I labelled Resistance. That was former support that was broken in a downtrend market. Price started pulling back and came back to the broken support which now was acting as resistance. At sell-1 price had moved above the horizontal resistance line but after some hours of consolidation, it was rejected by the bearish candle that closed back below the resistance line and that was our sell-1 entry signal. Notice that sell-1 did not produce a lower low swing before buyers took over again. As the sellers could not break the higher low structure with which buyers visited the resistance level. That kind of sell trade could land you into loss if profit made was not protected because the stop loss would have been hit. At sell-2 we noticed that price intended to test the downtrend trend line. We noticed a strong rejection of the buyers at the trend line and with sell-1 the higher low structure of buyers were broken and we saw downtrend resumption. At sell-3 price was already making lower high again in line with the present downtrend, and sell-3 entry was a very sweet ride.
Conclusion-How to Analyze support and resistance.
Support area or level is an area where buyers can come in to stop a falling price resulting to a rise in price. Resistance area or level is an area that has tendency to cause a fall in price. There are various types of support and resistance which include horizontal support and resistance, trend line support and resistance, and dynamic support and resistance. Support and resistance exist in all chart time frames but higher time frame support and resistance are more important than the ones in lower time frame charts like 1hr, 15m 5m and 1m. Support and resistance can be identified and market for visibility with the aid of trend lines and horizontal line tools on Mt4 trading platform. Support and resistance are more valid when tested multiple times. Broken support can become a resistance while broken resistance can become a support. To trade support and resistance, the trader should first analyze it to assess the likelihood of it holding and reversing price.
Final Word
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