Support And Resistance Levels The Complete Guide
> Support and resistance levels are commonly used concepts in forex trading. What is the easiest way to find them? Are there any special tips to make sure of the reliability?
A support level is the lowest area at which the price hits before it bounces back up again, therefore keeping the price from moving lower. In contrast, a resistance level refers to the highest area where the price hits before it falls, therefore keeping the price from going higher. It is crucial for all forex traders to understand the concept and able to determine support and resistance levels because it can be used as a reference at which the price will halt and most likely change direction.
There are many ways of identifying support and resistance levels. Traders can use various technical tools that aim to detect support and resistance levels, such as trendlines, Moving Averages, and Bollinger Bands. They are able to identify a support level when the indicator line is lower than the market price, and a resistance level when the indicator line is higher than the market price.
Fibonacci is also a popular tool aiming to identify price levels regarding corrections. Price correction itself refers to the temporary counter-trend movements which form zig-zag patterns in the chart. Fibonacci retracements are used as support levels during uptrends and as resistance levels during downtrends. In contrast, Fibonacci extension levels show resistance levels during uptrends and support levels during downtrends.
> See Also: 5 Powerful Strategies of Fibonacci Patterns
Based on the characteristics of the market and its participants, there are rules that are not explicitly stated but followed by almost all traders regarding changes in support and resistance levels, which also corresponds with the strength of the levels. Those rules are as follows:
* A support level will transform into a resistance if the price successfully breaks through it without changing direction. It also applies the other way around.
* An upward trendline that acts as a support line will revert into a resistance line when it’s broken, and vice versa.
* The Moving Average indicator that previously served as a dynamic resistance would change into a dynamic support once it’s broken, and vice versa.
* Fibonacci retracement in the uptrend direction that acts as a support will become a resistance if the price breaks through. This principle also works for the Fibonacci extension.
But apart from that, traders can also use only the price chart as a reference. This method would be very subjective where the trader’s experience would play a major role. That is why each trader may end up with different conclusions when finding support and resistance levels.
Still, the methods used to find the levels usually revolve around the same logical explanation. In this article, we will show you the 3 simplest ways of finding support and resistance levels and some powerful tips to use for trading around the support and resistance levels.
1. Locating the Psychological Levels
Have you ever wondered why most price tags say $99.20 or $99.50 but rarely $100? It is because human brains are naturally attracted to round numbers. As a result, you would think that $100 is way too expensive, so you feel like you’re getting a much better deal with $99.50.
In forex trading, psychological levels are the market price which often identified as round numbers, like 1.3000, 1.4000, etc. The price usually changes its direction when it reaches a round number like 1.4000, 1.5000, and so on because of the psychological reaction from the market. For example, the chart below shows how the price changed direction when it tested around 1.12000, 1.16000, and 1.20000.
Most traders would stay alert near the round number levels, waiting for a break to happen. When the price does confirm a break, the movement that follows tends to proceed in an extreme manner. If you use psychological support and resistance levels, it is possible that the price will break or pullback no matter the time frame. The most common psychological levels end in 2 zeros (for a 4-digit price quote), like 1.5400 or 105.00. The levels are even stronger if it ends with 3 zeros and 4 zeros. For example, round numbers with 4 zeros such as 70.000 on AUD/JPY will attract more attention than, let’s say, 70.100 on the same pair.
2. Drawing from the Price Swings
The second way of finding support and resistance levels is by using Highs and Lows. The rules are simple: if the price fails to move higher than a certain High, then it becomes a resistance point, whereas if the price fails to go lower than a certain Low, then it becomes a support point. When you connect at least two Highs it will become a resistance level, while two or more Lows can indicate a support level.
If you look at the chart above, the prices tend to change direction after hitting the support and resistance levels drawn from Highs and Lows. The more the price hits the points, the stronger the resistance and support level. Traders who want to trade in a sideways condition where the price moves up and down within a range can place a buy position near the support level and sell near the resistance level.
The price changes are usually caused by a change in supply or demand in the market. While there can be numerous reasons why this happened, the most obvious one is that traders simply expect the price to change direction once it reaches the High/Low point of the past movements. Anticipating for the direction change in the future, they will be looking forward to this area as a setup for a potential trade, increasing the reliability of the support or resistance area.
3. Calculating Pivot Point Levels
Pivot point levels are generated by a specific formula that calculates the past price levels to determine potential turning points in the chart. Pivot points use the previous day’s Open, High, and Low to calculate the points for the current day. Traders often see these pivots as markers for support and resistance levels. In forex trading, pivot points are often used by day traders that prefer shorter time frames.
Pivot points can be accurate and objective, but compared to psychological levels or price swings, the accuracy of pivot points as support and resistance levels is relatively low. When the market experiences high volatility and the price moves very fast, pivot points are usually incapable of indicating the right key levels.
> See Also: Predicting Trends Using Pivot Points In Forex Trading
After figuring out the easy ways to determine the support and resistance levels, it is also important to know which levels are stronger and more reliable. Technically, you can see the accuracy of the levels from the price changes. When a price fails to break a certain level in the past, then it can be assumed that it will potentially fail again in the future, thus making the level stronger as a support or resistance.
Tips on Determining Support and Resistance Levels
You can use the three methods above separately, or combine them in order to find a stronger support and resistance level. For example, you can find a support where a certain Low coincides with a psychological level or an R2 pivot that is in line with a High swing. Confluences are after all more reliable than a single signal.
Furthermore, there are several essential guides on how to best incorporate the methods above in your trading strategy. The following tips would tell you the details:
1. Determine your Time Frame
One of the most common confusions about support and resistance levels is about the best time frame to use. There is no definitive answer to that because, in reality, the market does leave similar tracks on certain levels in the past and there is no guarantee that such pattern will always happen again in the future. However, it is evident that the more often the pattern shows up and repeats itself, the more valid the levels.
While it is vital to look at the past price changes, we don’t have to go way back to let’s say, twenty years ago because the market always changes and the market condition back there may not be relevant anymore right now. Therefore, you can start by analyzing the weekly chart first. Starting off by finding support and resistance levels in the long-term chart will help you identify the most influential levels.
> See also: Using Multiple Time Frames in Forex Trading
Many traders believe that long-term charts will show the more valid levels compared to the short-term ones. For example, in the following GBP/JPY chart, you can see that the horizontal lines were drawn from the important levels where there is a trend correction in the span of two years. These long-term support and resistance levels can then be considered as key levels.
The next step is to determine the support and resistance levels in a smaller time frame, which is the daily chart. Here, it’s possible to spot new levels that are not visible in the weekly chart, including the levels that may affect the chart in the near future (near-term levels). Near-term levels are usually more significant for short-term movements.
If we look at the chart above, you can see that the 184.222 level is marked as a near-term support although it doesn’t appear to be a key level on the weekly chart. In addition, there are adjustments to the key support previously set up in the weekly chart. Such adjustments are made based on the relative positions to the Highs and Lows. However, the daily charts’ adjustments mostly have a few pips difference, usually no more than 50 pips.
Now if you are a day trader, it would be wise to add an additional step that involves analyzing the chart in even a smaller time frame, namely the intraday charts (4-hour and 1-hour). Using the same principle as the previous step, you can check the accuracy of the key levels from the weekly and daily charts, and find new near-term levels. It has become common knowledge that long-term traders will focus more on the daily chart, while day traders often use the support and resistance levels on the 4-hour chart as a reference.
> See Also: Powerful Tips from 5 Successful Day Traders
2. Know the Difference between Key Levels and Near-term Levels
Based on the GBP/JPY example above, notice that there are key levels and near-term levels. Basically, near-term levels are different from key levels because they only appear on smaller time frames. In other words, near-term levels usually have no effect on the long term but can affect the chart in the short term and they are typically closer to the current market price.
Meanwhile, key levels on the weekly chart are typically very significant especially in the medium and long term, either in the form of trend continuation or trend reversal when the market price has reached said levels. Key levels are the most significant areas to watch for signals and look to trade from, but near-term levels are also important. Although key levels are sometimes still relevant in the smaller time frame and therefore not to be ignored completely, you should pay more attention to the near-term levels if your strategy focuses on intraday trading.
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3. Support and Resistance are Mostly Areas
After finding out the support and resistance levels, don’t expect the price to always reverse or break the exact same level. Many traders would think that the support and resistance are fixed price levels, but in reality, it isn’t. You will often see price movement that seems to break through a support or resistance level, but soon after the price is going back even after “dipping” out of the line.
Take a look at the example below.
For that reason, you don’t have to regard the levels at an exact price level. Most traders would perceive the support and resistance levels as zones rather than exact lines. You can think of these levels as the estimated points where the price may change its course or show a breakout that leads to a great momentum for a trend continuation. Therefore, in the actual trading, don’t be so quick to react to the market if the price suddenly seems to break through the support or resistance line. Give it a little more time for the market may regard the support and resistance as a price range rather than a price level.
More importantly, you just have to focus on the key levels and most obvious near-term levels. If you draw too many support and resistance lines, you will begin over-analyzing the market and got confused. While it may be hard at the beginning to determine where the most logical support and resistance level should be, it is definitely something that will improve with experience.
The concept of support and resistance level is used as the basis for many forex trading strategies. That is why it is better to understand these concepts as early as possible. After all, figuring out random price movements in the chart may seem to be a difficult and somewhat impossible task. It will be easier to figure out a price chart and spot potential price changes as trading opportunities once you determine the support and resistance levels.
Nonetheless, finding the most ideal support and resistance can be a little tricky as it is a subjective analysis that may spark some doubts when you still lack experience. But as long as you still use the logical approach to find support and resistance levels, you will figure out the general key levels to anticipate for breakouts or reversals.
> See Also: Best Price Pattern For Forex Trading: Trend Reversal
In the end, determining support and resistance level is actually not that hard. When in doubt, ask yourself if the levels you’re about to put down make sense and why. If your lines are based on a logical approach, you will save yourself some time and reduce frustration while trading. To sharpen your skills in spotting support and resistance levels, you may need to do it with minimum risk, so practicing in a forex demo account is a necessity.