Welcome to part 1 of the Forex support and resistance trading tutorial from Forex Firefly. Many traders like to discredit the value of technical analysis in trading and sometimes they are justified in doing so, in some markets it just does not work that effectively. The Forex market is however one of the ‘purest’ markets as far as technical analysis and support/resistance trading is concerned. The reason for this is that for the retail trader, the Forex market is known as a ‘blind’ market. This means that we are unable to clearly see the flow of orders on each side, we do not know who is buying or selling or what quantities are involved. The lack of this information (which is often available via level 2 and 3 screens while trading stocks) makes technical analysis, and therefore support and resistance, a vital aspect of Forex trading.
What is Forex Support and Resistance?
Support and resistance levels represent points on a chart where the price has previously stalled, bounced or reversed or some other important level which is expected to affect the price action such as a significant round number. These levels can occur on short term or long term time frames. The more times any particular level has affected the movement of price and stopped it in its tracks, the stronger the level is said to be. For example, if price has tried to drop below a certain point many times but repeatedly failed to do so, this will be perceived as a strong support level. Forex Support and resistance levels are traditionally horizontal but there are also other kinds which travel diagonally, sometimes forming different patterns. These will be looked at in another article.
Forex Support Levels – Areas which price cannot seem to break below. If a break does happen, this is only temporary and the price will soon return above the level.
Forex Resistance Levels – Areas which prevent the price from rising further. These levels act like a ceiling and appear to force price back down when it tries to break above the level.
It is important to note that in Forex support and resistance trading the levels will not always hold, especially on short term time frames. While the market is in a strong trend, the levels will often be broken fairly soon after they are first established. This gives rise to the famous zig-zag formations which you may have seen. Here is a simplified diagram showing how support and resistance allows a trend to pause and continue. Obviously price will move around more erratically than this, but the general principle of price moving in waves during a trend is shown here.
Forex Support and Resistance in a Trend
As we can see from the image above, these levels can easily be broken the next time the price approaches them. This is not always the case though. When the market is in a range or a trend that is coming to an end, Forex support and resistance levels can remain strong and stop price completely, sometimes even causing it to reverse and change direction.
Below you will see a GBP/USD 1 hour price chart from October 2010. At points 1 & 2 there are clear examples of these levels holding and refusing to break, even as the price approaches them more than once. The arrows show each attempt made at breaking through the level. It is clear that after two attempts to break support at point 1 and four attempts to break resistance at point 2, the price changed direction.
Forex Support and Resistance Trading
Points 3 & 4 show another common situation seen in FX support and resistance scenarios. When a support level breaks (point 3) the price will often return to it from below (point 4). The same level then acts as resistance and forces price down again. The reverse is also true – a resistance level can be broken and then act as support after price moves through it and then returns to it from above briefly before continuing its journey upwards and away from the level. These are favourite trading setups of many experienced traders and ones you will see time and again while you learn Forex trading online.
Will a Level Break or Hold?
This is a classic question and one that you will come accross many times as you learn to trade Forex. These Forex support and resistance concepts are of course just tools which can give you clues about how price may behave at a certain level in the future. The levels themselves are also not set in stone. Price may move past a level, but this does not necessarily mean that it has broken. Often after a candle has closed, only the shadow will remain over the support or resistance line in question. Even a close beyond a level does not guarantee a broken level though, many traders wait for the price to come back and re-test the level from the other side before placing a trade. This is often a high probability set up and one which allows you to place support and resistance Forex trades with a small stop loss and little risk.
In order to minimize the chances of being caught out by these kinds of movements, it will often help to think of support and resistance areas as ‘zones’ rather than exact price levels. The blue area in the chart below is an example of a resistance zone. The price has turned around here on several occasions, but the level where it stopped was not the same each time. It has however reversed in the same general area – the resistance zone.
Forex Resistance Zone
Using these zones will allow you to avoid losing trades due to ‘false’ breakouts or ‘fakeouts’ where the price temporarily passes a level but then quickly reverses and continues to respect the support or resistance area.
Forex support resistance levels are a key part of technical analysis in currency trading. You will find that a very large number of professional traders use them during their daily activites, and to great effect. These levels are most effective when combined with price action, technical indicators and other pieces of information such as volume. It is however possible to develop a forex support and resistance strategy which uses these levels and nothing else.
We will be looking at other examples of support and resistance trades in parts 2 and 3 of this series.
