The key concepts of support and resistance are undoubtedly among the most important and most followed aspects of both technical analysis and forex trading in general. Whether you are a technical trader, a fundamental trader, a combination of the two, or something else altogether, chances are that you follow support/resistance principles at least to some degree in your forex trading.
For those that are new to the concept of support and resistance, a quick definition here should be helpful. Price changes and fluctuations in any financial market are caused by shifts in the basic economic factors of supply and demand. Support is a price region where demand is considered sufficiently strong to halt price from making further declines – it can be considered a price “floor”. Therefore, price is expected to turn up at this region after a decline. If price instead breaks down below support, it is reasoned that the strength required to break that price floor should carry the follow-through momentum to make further declines.
Resistance, on the other hand, is a price region where supply is considered sufficiently strong to halt price from making further gains – it can be considered a price “ceiling”. Therefore, price is expected to turn down at this region after an advance. If price instead breaks out above resistance, it is reasoned that the strength required to break that price ceiling should carry the follow-through momentum to make further gains.
This is a key rationale behind breakout trading: if price carries strong enough momentum to break through a support floor or a resistance ceiling, it should also carry the momentum to follow-through and move even further in the direction of the break.
There are many different methods for denoting support and resistance levels. Among these different methods are: horizontal lines where price turned or made significant highs/lows in the past, angled trendlines and parallel trend channels, pivot points, Fibonacci levels, Gann studies, Andrew’s Pitchfork, Bollinger Bands, moving averages, and many others.
Among these methods of pointing out support and resistance, simple horizontal lines denoting where price turned in the past are one of the most logical and reliable methods. This is due to the fact that much of the support/resistance phenomena that we see on currency charts is derived from traders’ memories of specific price levels, and whether traders consider these specific price levels to be relatively high or relatively low. This is partly what creates the buying and selling pressures at different levels. Also, support/resistance is somewhat of a self-fulfilling prophecy in that a critical mass of traders will often trade based upon previously visited levels where price turned before. Finally, and very importantly, large institutional orders are often placed in certain established price zones. When price action reaches those zones, significant price events often occur.
As alluded to above, trading with support and resistance entails looking for either respect or violation of price levels (or, perhaps more appropriately, price zones). Respect comes in the form of bounces, while violation comes in the form of breaks. The difficult part of this is knowing when price is truly respecting/violating a support/resistance level, and if there is actually any follow-through to the price move. Lack of follow-through on a bounce or break, false breakout moves, and choppy whipsaw around key levels, remain as among the most frustrating aspects of support and resistance trading.
The most important method for dealing successfully with all of this potential uncertainty, and thereby trading effectively with the principles of support and resistance, is a proper risk management plan that helps ensure losses are controlled and profits are protected. Only with a good, solid risk management plan can the potential for consistent trading success be achieved.