For anyone who wishes to understand the nuances of trading, there are many concepts that need to be covered. Anything that is an integral part of a trade and impacts the movement in the prices can be a critical topic to master. One such is the twin concepts of support and resistance in the prices and this applies to all trading, including forex.
Introduction to Support and Resistance in Forex Trading
A trader looking to get a good grip on the forex market and its operations will have to depend heavily on technical analysis. Tools like chart patterns are indispensable to assess the movement in prices and to make decisions on what and when to buy and sell.
While interpreting technical charts and studying patterns, the concepts of support and resistance are crucial to help you understand the state of the market and the currency pairs being traded.
A general definition of support is a price level where an asset, a stock or a currency, faces an increased demand due to which the falling price is arrested. Resistance, conversely, is the price level where the demand falls and the rising price sees a reversal following the occurrence of a sell-off.
There is a lot of trading psychology that comes into play when we talk of support and resistance. In reality, these levels are a demonstration of the psychological barriers that traders encounter when looking to buy or sell.
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The Role of Supply and Demand in Forex Trading
As happens in any market – the stock, commodity or even the retail – the role of supply and demand is just as relevant in forex trading too. A trader needs to appreciate the role of supply and demand in context to that of support and resistance.
A market with something to sell and two parties to buy and to sell will always witness the phenomenon of supply and demand. This is like a seesaw where, depending on external variables, there will always be one dominating the other. Depending on the market in question, there will be a slew of factors that drive either supply or demand.
In forex trading too, this holds true as the supply and demand play their role in determining the price in any currency pair being traded. The other side of the coin is the variations in the price with regard to its support and resistance levels can affect the supply and demand of the currency pairs being traded.
But supply and demand vary from support and resistance and the two sets of concepts differ from each other too. While supply and demand relate to zones without a price demarcation, support and resistance are levels where prices are defined.
When traders find the price of a currency pair compellingly high enough to sell it, it is said to move into a selling zone with supply trading taking over. As opposed to that, when the price falls low enough to have moved into a buying zone, traders resort to demand trading by purchasing it.
On a technical chart, the trading activity can show the levels with the supply and demand displayed in a specific zone. But the support and resistance comes across as a wider zone in pricing terms.
This relation between supply and demand on one hand and support and resistance on the other is what forex traders need to understand. To sum it up, if supply has a connection with resistance then demand has the same with support.
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Support and Resistance in Action
A forex trader who wishes to make informed decisions based on technical analysis needs to be comfortable with both the theory and its practice. This can be a major contributor to how well you can both manage risk and improve the chances of increasing the rewards.
In a trading scenario, support and resistance are important milestones in the movement path of an asset’s price. These play a big role in a trader’s decision on when to step in to make a purchase and when to effect a sale. These are the triggers that both justify and validate the next trading move you will make.
When a trader observes that the asset he is following has seen a pause in its fall and is beginning to revive on to an upward direction, he sees support in action. Conversely, when an asset whose price has been on the rise starts to slow down and sees a directional change and begins to fall, it is resistance kicking in.
As a trader following an asset, support and resistance are the levels that prompt you to take a trading call. But there are instances where these levels could get breached and the direction continues.
The occurrence of support and resistance can also be better understood when seen in the context of the availability of buyers and sellers for the assets. When there is a resistance encountered, it is on account of an excess or surplus of buyers for the asset. On the flip side, when a support is seen for an asset, this can be a result of the presence of an excess or surplus of sellers for it.
Working with Support and Resistance
When working with support and resistance, you can spot these in the pattern displayed in the zigzag indicators. Every time the price rises, the point where it was at its lowest is the support while in a fall, the level it had reached the highest is the resistance.
These points and levels nudge you to watch out for a resistance when the price goes up and a support for a price drop. From a trading standpoint, the reaction from a trader is as follows.
When the price starts falling in the direction of the support, it points to a buy. When the price starts to rise in the direction of the resistance, it should be a sell. This is also called trading the bounce.
When the price of an asset manages to break through the support level, this warrants a sell. But when the price breaks through the resistance level, it calls for a buy.
A trader can expect to be rewarded when attempting a buy around the support or sell near the resistance levels. But there is no assurance that these levels will maintain their position as predicted. The challenge is in identifying these levels with greater accuracy so that the chances of recording gains are higher.
The theory apart, when you have to start using support and resistance actively in your trading, here are a few points to consider.
To begin with, these are not specific prices you will be working with but a range or a zone where the price change begins to happen. When observing it on a chart, it will be evident when you see the variation begin to build along a horizontal line drawn.
Also, keep a closer watch on the price changes that happen in the middle and display more congestion, rather than the extreme points. These are more reliable levels for support and resistance as the outright high and low, typically, evokes more of a kneejerk and panic reaction from traders.
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Major and Minor Support and Resistance Levels
To understand these concepts further, we can separate a temporary state from a permanent one by bringing in the elements of major and minor support and resistance levels.
When the fall or rise in price gets temporarily delayed in the course of the overall trend, this points to a minor support and resistance level. But if the course of the price movement faces a total stop in fall or rise of the price, it is said to have faced a major support or resistance.
To understand the role of support and resistance levels in assessing a drop or rise in its prices, there are tools and methods used by analysts and traders. These help in determining these levels and offering an insight in the identification of trading opportunities and make buy and sell decisions.
Pivot Point is a tool often used by traders in their technical analysis can be especially helpful in identifying the levels of support and resistance. With this, it is possible to spot when a market is taking on a bull or a bear sentiment. This enables analysts to calculate the average value of an asset’s price at its highest, lowest and at the time of closing for a previous trading interval.
Some of the most popular tools to do this include Fibonacci Retracements, Moving Averages and Trend Lines.
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