Forex Trading Basic

Technical Analysis with Support and Resistance Levels

Pivot Point Break Out Strategy in Forex Trading

The concepts of support and resistance represent the backbone of technical analysis. They are undoubtedly the two most highly discussed topics of technical analysis, and every serious trader should know how to identify and use them properly. The terms refer to price levels on charts that tend to act as barriers, preventing the price of an asset from getting pushed in a certain direction beyond a certain point.

How to determine Support and Resistance levels?

There are many different ways to determine the Support and Resistance level, such as using recent price motion, pivot point formula, and Fibonacci lines. This article is going to focus on price motion.

Support and Resistance levelsIn its simplified form, horizontal support and resistance looks something like this:
I have drawn the zigzag pattern of an upward moving bull market. When the market moves up and then pulls back, the highest point reached before it pulls back is called resistance (blue line), while the lowest point reached before the market jumps back up is called support (green line). If the market is bound within a support and resistance, it’s called being in a channel, and in the above diagram, there are three of them. Within each channel, the more the market retests or confirms each level of support or resistance, the stronger each level is said to be. In the diagram above there at least two retests of each level, with the first and second resistance levels being ultimately penetrated on the third attempt. When the market breaks the resistance of the first and second channels, the former resistance becomes support and acts as a new barrier to push back the market.

While the markets sometimes form patterns similar to the one above, it should be understood that the markets are always dynamic and volatile; they appear different for each new day and each new timeframe, and thus identifying (let alone profiting from) these support and resistance levels is neither exact nor easy. The Greek philosopher of change, Heraclitus, once said that, “you cannot step into the same river twice,” and the markets are an excellent example of this, seeming to put everything in hyper motion, even hyper-time as they collapse a speculative future into the present price. Markets shift, ebb, and flow, forming zigzag waves, and if we look hard enough we can see some structure, when resistance and support form to contain the motion, but in time they too will erode, disintegrate and prove invalid.

This article will seek to help the reader identify and draw these support and resistance levels as they form or shortly afterward, so you can take advantage of them before they become irrelevant.

What Is Support? How Can One Profit From It?

Support is named support because it is the line traders expect to support the price, and the line traders won’t let the price fall below. It is the price level at which buying pressure is so strong that it acts as a floor, preventing the price of an asset from being pushed downward.

Support can be drawn using the horizontal line object tool in MT4, and you can insert this horizontal line along the lows of the trading range, the closes of lower bars, or a combination of the two (wherever it seems the market has touched down and bounced up again). Make sure your horizontal line touches these lows and closes more than once. The more retouches (called retests) of these lows, the stronger the support is said to be.

Example of GBPUSD on H4 timeframe: 

Support and resistance levelsThe above chart shows how multiple retests of the lows can act as support. In the first channel, the market had touched the 1.6105 level on four separate occasions, each time confirming the strength of the support until finally it had to break beyond the relatively weaker resistance that had formed on only two touches. The second channel seems to be a déjà vu of the first. The market retouched the 1.6285 support level on five separate occasions, each time confirming the power of the support. So far the resistance was touched only twice, and it looks as if the market is heading back up to touch it again, if not break through.

Also, pay attention to former resistance levels that were breached, as these can act as new support levels, particularly if there is no immediate support level. A prior resistance level broken in the past, especially if it was a tough resistance level (with multiple retests), can act as a powerful support. You have to make sure to draw a horizontal line from the former resistance level across to the blank area underneath the current price action. If the price then bounces from this level, you have a confirmation that that is indeed a strong support level.

Strategy #1: Buy On Bounces Of Support

The logic behind support is that as price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. If the larger trend is currently bullish, then a sound strategy is to take up buy limit positions along support levels, to take advantage of the better price and the swift bounce up, if the support is strong enough.

Bear in mind that support does not always hold, and a break below support signals that the bears have won out over the bulls. Support breaks and new lows signal that sellers have reduced their expectations and are willing to sell at even lower prices.

Strategy #2: Sell On Breakdowns Of Support

A second strategy is thus to be prepared for a breakdown through support. You will be a seller looking for a breakdown through support, perhaps at the line itself, but even better at a confirmation point x number of pips below support. Once support is broken, another support will have to be established at a lower level, perhaps at a former resistance. Also, once support is broken, it becomes a new resistance, providing back up for your short trades.

What Is Resistance And How Can One Profit From It?

Resistance is named resistance because it is the line traders expect to resist the price, and the line traders won’t let the price rise above. It is the price in which selling pressure is so strong it is said to act as a “ceiling,” preventing the price of an asset from being pushed upwards.

Resistance can be drawn using the horizontal line object tool in MT4, and you can insert this horizontal line along the highs of the trading range, or the closes of higher bars, or a combination of the two, wherever it seems that the market had hit a ceiling and bounced back down again. Make sure your horizontal touches these highs more than once. The more retouches (called retests) of these highs, the stronger is the resistance is said to be.

Example of EURUSD on H4:

Support and resistance levels

The above chart illustrates a very powerful level of resistance that first formed on March 22 2011 at 1.4250, which was the swing high of that week, and then a week later (the first week of April), traders had tried to repeatedly retest that level, slamming their heads again and again into that ceiling. At one point it looked like six or so H4 bars ended up with their highs near that level. It eventually fell back to the 1.4155 support confirmed in the last week of March, and when it held firm, it was the signal for traders to make another stab at resistance. The market bounced upwards from support with enough force to finally break the stubborn resistance of 1.4250 on April 06 2011, going on to see a new 15 month high of 1.4350 within that day. Interestingly, the traders took an opportunity to retest the former resistance, now support, of 1.4250 on April 07 2011, and the bounce from it is currently driving the market back up.

Resistance Strategy #1: Sell On Bounces of Resistance

The logic behind resistance is that as price moves up towards resistance, sellers become more inclined to buy and buyers become less inclined to buy. If the larger trend is bearish, then a sound strategy would be to take up short limit orders at or near the resistance lines, being prepared to exit at the confirmation of their break.

Resistance Strategy #2: Buy On Breakouts of Resistance

You can see from the above charts resistance does not always hold and break above resistance signals that the bulls have won out over the bears. Thus, a second strategy that becomes profitable is to put in buy stops at a breakout, perhaps x pips beyond the resistance level in order to confirm it as a valid break. If the resistance breaks, new highs signal that buyers have increased their expectations and are willing to buy at even higher prices.

If the larger trend is up, as in the case of the USD/JPY and EUR/USD charts above, you should be prepared to become a breakout buyer. The trend is your friend, and a zoom out to the daily picture can give you an idea of the trend direction. Once resistance is broken, another resistance will have to be established at a higher level, perhaps at a former resistance. Also, once resistance is broken, it becomes a new support. This new support can act as your friend, in order to take bounce trades in the direction of the trend.

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Please note that: Successful Technical Analysis largely depends on the functionalities of the MT4 Platform provided by your broker. If you are new in forex trading, you might consider reading the article on what is the best trading platform, Introduction to MT4 Platform and MT4 Platform functions. We have used a fully functional MT4 platform provided by HYCM Broker. Read why their MT4 platform has better trading conditions from the HYCM Broker review.

READ MORE

Chapter 5

Technical Analysis in Forex Trading

Lesson 1Types of Technical Analysis Indicators
Lesson 2Forex Trading Trendline Analysis
Lesson 3Forex trading Chart Patterns
Lesson 3.2Double Tops and Double Bottoms
Lesson 3.3Head and Shoulders Pattern
Lesson 3.4Rectangle Chart Patterns
Lesson 3.5Triangle Chart Patterns
Lesson 4Japanese candlestick Trading Strategy
Lesson 4.2Japanese candlestick Trading Strategy Part 2
Lesson 5Support and Resistance Levels
Lesson 6Types of Technical Analysis Indicators
Lesson 6.2moving averages Technical Analysis
Lesson 6.3MACD Indicator Technical Analysis
Lesson 6.4RSI Indicator Technical Analysis
Lesson 6.5Stochastics Indicator Technical Analysis
Lesson 6.6Technical Analysis with Bollinger bands Indicator
Lesson 7Fibonacci Retracement Forex Strategy
Lesson 8Forex Trading Pivot Strategies

Go back to Main Page: Forex Trading for Beginners

About the author

Syed Nazim

Syed Nazim is the Marketing Manager of RedMaroon, a Digital Marketing Agency for Financial Institutions. He is also involved with Forexing24.com as a writer and financial Analyst. He is a brilliant marketing geek with vast experience in every sector of Digital Marketing. He likes sharing strategies, tactics and proven methods to help you build a business and live the life of your dreams.

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