What are support and resistance and how to use them in Forex

When starting out trading the first question everyone has is how to know when to buy or sell currencies. Traders use various techniques in order to predict future prices. These techniques fall into two main categories: technical and fundamental analysis. Fundamental analysis studies the current events that give markets direction, for instance, trading balance, interest rates, unemployment numbers, inflation, etc. Technical analysis studies the past performance of given currency pairs and makes predictions based on the belief that what has happened many times before, is more likely to happen again in the future.

In technical analysis, the simplest and most highly effective tools for predicting future prices are support and resistance levels and support and resistance areas. Both novice and seasoned traders use these levels intensively.

Support and resistance in forex

Support and resistance levels are widely used in trading all kinds of assets. In forex, these levels help traders predict areas that will hold a price and keep it in a range. There are various reasons why these levels work:

• Levels work because technical traders believe they work and avoid placing orders against them, which makes them a self-fulfilling prophecy.
• Support and resistance levels work because traders that prefer to only buy or sell currency pairs from certain prices make it work.

Every asset class is different and each asset price moves differently on charts. However, the concept of support and resistance is equally important for all of them.

Support and resistance levels are only a single dimension when opening an order is considered. Support and resistance levels are not always clear. And when they are, they can be coupled with various indicators and trading strategies to increase the likelihood of success. For instance, if a price gets closer to the trendline and volume indicators signal an increase in trading activity, this might be a sign of an upcoming breakout.

Support and resistance levels

It is easy to draw support and resistance lines on the chart. Which is why beginners learn how to use them very quickly. In order to draw the lines, first you should visually make sure that the price action respects certain levels on the chart. If the price makes too volatile moves and nothing seems to be holding a price in a range, we do not have support and resistance levels. If a price reaches and touches a certain point and retraces, it means that we have a support or resistance level. Support and resistance levels are horizontal when a market is ranging. When the market is in a trend, we have tilted support and resistance lines as you see in the example. The more touching points the trendline has, the stronger it is.

There are two general ways traders trade support and resistance levels:

• Traders place market or limit orders and predict that the price will retrace. Stop loss is placed below support or over a resistance trendline (depending on the trade direction). And profits are taken once the price reaches (or near) an opposite trendline. Typically these trades offer good risk to reward ratios.
• Traders place market or limit orders once price breaks out from a significant level. There are various ways traders can trade breakouts. Traders can join the trade once the breakout happens. They might wait for the confirmation candle to make sure that it’s not a false breakout, or wait for the price to retrace, test the trendline from the opposite direction and join the trade later. In any case, the levels offer good risk to reward ratios.

Support and resistance area

In addition to support and resistance levels, there are support and resistance areas. In forex, it happens quite often that the price does not respect a single level, but retraces from around that area. In other words, support and resistance areas hold the price in a certain range or in a certain trend.

Similarly to the support and resistance levels, areas can be traded when breakout occurs or when prices retrace. An obvious downside of trading support and resistance areas is that a much larger stop loss target will be required compared to trading with levels. On the upside, support and resistance areas are more common on the market.

Strong support and resistance levels

There are a couple of things that can make support and resistance levels stronger or weaker. In general, the more price touching points a trendline has, the stronger it is. As you can see in the example, price breached the support trendline and started testing the level from below. When support becomes the resistance (or vice versa) we get the strongest level.

In addition to touching points, round numbers can play a role in creating support and resistance levels. However, this is less true in forex and more noticeable in Stocks. Round numbers create support and resistance levels because when traders place limit orders, it’s easier for them to select round numbers. And the limit orders are the order types that keep prices from breaking the trendlines.

Weak support and resistance levels

Very rarely price makes all time highs (ATH) or all time lows (ATL). On such occasions there are no prior prices that can work as support and resistance levels. When a price retraices from ATHs and ATLs, traders get significant levels. However, these levels are not strong. If price touches these levels a couple of times, they become more important. The more touching points support and resistance levels have, the stronger they are.

The weakest support and resistance level is a trendline that has a single touching point. It’s best to avoid trading weak support and resistance levels or trade them in the combination with other technical and fundamental tools.

Example of support and resistance in forex

As you can see from this British Pound/Swiss Franc example, the price was ranging between 1.10075 and 1.09842 levels. The price finally broke out, tested the level from an opposite end and continued moving downwards. In this case, we could place an order after the breakout confirmation candle started forming. Stop loss would be placed over the support line. Which would give us a great risk to reward ratio. As you can see, the support has multiple touching points. Once the price breached the support level, the support became the resistance. And therefore, the level is strong.

Support and resistance indicators

As we have already mentioned, traders can manually draw support and resistance trend lines on the charts. However, for those who prefer using indicators, there are various formulas developed to signal potential resistance and support areas. The most widely used indicator in this regard is Fibonacci retracements. Fibonacci retracements measure how much a prior move of the price has retraced. The Fibonacci retracements are calculated in percentages and the percentage levels are 23.6%, 38.2%, 61.8%, and 78.6%. In addition to these levels, traders often use 50%.

The indicator is easy to use and can be drawn between two significant price points, for example between the highest and the lowest points of a price swing. The indicator will automatically display potential support and resistance levels.

The main takeaways

To sum everything up, support and resistance levels and support and resistance areas are highly utilized by both professional and novice traders in Forex. Levels can be drawn manually on charts. In addition, there are various indicators developed to display these levels, Fibonacci retracement is among the most popular ones. There are two major ways traders can trade these levels. The first way is to trade in the retracement direction. The second way is to look for the breakouts. In any case, the risk to reward ratio is amazing. However, false breakouts happen quite often and it’s probably best to use confirmation candles or other indicators in combination. The more touching points a trendline has, the more strong it is. What’s more, round numbers can become significant levels as well, however, it is less common in the forex market. Support and resistance levels work because they are simple to use, most traders are using them and it makes them a self-fulfilling prophecy. In addition, traders that prefer to only buy or sell from a certain level, help create the support and resistance levels.

FAQs on support and resistance in Forex trading

How do you determine support and resistance?

Support and resistance levels and support and resistance areas are easy to spot on the charts. In order to determine levels traders use simple lines that are placed manually. Price should be touching these lines and respecting the levels. If a candle crosses and closes outside a support or resistance line, we have a breakout.

What is the best indicator for support and resistance?

There are various indicators in the market developed to identify support and resistance levels. The most famous indicator is called Fibonacci retracement which uses 23.6%, 38.2%, 61.8%, and 78.6% levels that serve as support and resistance. Simple lines manually drawn on the chart by the traders are also very effective and both professional and novice traders are using them.

What makes support and resistance levels strong?

There are a couple of things that can make support and resistance levels stronger. In general, the more touching points a trendline has, the stronger it is. If a price breaches a trendline and starts testing it from an opposite direction, the significant level becomes stronger. In addition, round numbers can make support and resistance levels stronger.

What is the difference between support and resistance level and support and resistance area?

Support and resistance levels have single trend lines that are respected by price action. The trendlines can be horizontal or tilted towards trend direction. Support and resistance areas do not have single points in price that are respected, they have significant areas instead. In other words, price retraces not from a certain point but from around a certain area. Support and resistance levels make it possible to place smaller Stop Loss orders and provide great risk to reward ratios.