Forex Education: Support and Resistance

Forex Education:  Support and Resistance

Perhaps the two technical analysis terms that are most commonly used in the forex markets are “support” and “resistance.”  In short, a support level is an area (which can be easily identified on chart graphs) where buyers have stepped into a market asset (currency pair) and kept prices from falling any further (in essence, “supporting” prices).  These areas can be identified on price charts by looking at areas where prices were seen dropping before a quick reversal and rally higher.  Traders tend to views these areas with a bullish bias (positively), as buyers will be expected to enter into the picture if prices happen to fall there again.

Resistance, however, would be the opposite scenario, in that these are areas where prices have risen strongly -- only to be met with bigger selling pressure and eventual declines.  These resistance areas can be identified on charts by finding areas where prices have seen strong rallies, only to later encounter reversals and a sharp drop lower.  Traders tend to view these areas with a bearish bias (negatively), as sellers are expected to re-enter into the picture if prices are seen rising to this level again. 

Using Significant Levels as the Basis for Trades

So, how are trades placed using support and resistance levels?  Since traders tend to view support areas favorably (and expect prices to rise at a later time), support levels are generally viewed as an excellent area to enter into “buy” positions.  While it is possible that support levels will not hold prices the same way they did in the past (and prices might drop even lower), most traders would argue that the odds are in favor of rallies after support levels are tested, and this increase in probabilities is enough to place bullish trades.            

In the same way, resistance levels can be used to place trades, only in the opposite direction.  Since resistance levels mark areas where sellers are expected to re-enter the market, traders often view these regions as excellent areas to sell a currency pair (in anticipation of declines to be seen later).  “While it is true that sometimes resistance levels do not contain prices (and rallies extend even further) traders generally argue that there is an increased probability for price declines once a resistance level is tested,” said Haris Constantinou, currency analyst at TeleTrade. “Because of this increase in forecasting probabilities, short trades can be placed in these areas.

If it becomes difficult to remember which area is which, simply remember that resistance levels are seen above the current price and indicate potential selling opportunities.  Conversely, support levels are likely to “support” prices and are seen below the current price level.  These areas offer good areas to buy a currency pair with prices more likely to rise later.  These price regions help traders outline some of the most popular technical analysis strategies.  This is the case for two reasons:  Support and resistance zones can be quickly idenfied on price charts, and they give traders a clear indication of how markets have behaved in the past.