Forex trading is an exciting market. Firstly, the amount of money involved is beyond imagination. It reaches as high as six trillion dollars per trading day.
If you can count one dollar per second, it will take you 31,688 years to count to one trillion dollars. That is if you count non-stop and without any breaks. Not even to go to the toilet or get a quick nap. It will take you 190,128 years to count six trillion dollars! You will be long dead before you finish a small fraction of that amount.
Another factor that makes it attractive is the unpredictable movement of the price of currencies. The value of a forex currency can move up or down in a matter of minutes. It gets affected by many factors like government policies, economic indicators, and health issues.
The behavior of the traders can also have a positive or negative effect on the value of currencies. But all these internal and external factors do not mean that it is hopeless to trade in forex. It is possible to be successful in trading. But you must develop your skills, discipline, and substantial capital to make it a profitable journey.
Every forex trader needs to develop analytical thinking. You must be able to identify trends and patterns. And then make sense of it all. A popular skill used by professional forex traders is technical analysis. It is the study of price movements in the past to make informed decisions on where the price will move to in the future.
The value (of the currency pair) is the single and most important data in any technical analysis process. Both support level and resistance fall under the skill of technical analysis.
Support level and resistance levels are areas or zones in the historical value of a forex currency. It is where the prices are likely to rally up or down. Support happens when falling prices stop at a certain point, change their direction, and rise again. Support is also known as a floor since it supports or holds up prices and is the point where the price will bounce up. On the other hand, resistance happens when rising prices stop at a particular level, change their direction, and start to fall. Resistance is also known as a ceiling since it keeps the value from rising higher.
But the resistance and support levels are not exact. The value of the currency may go over or below this range. When this happens, the resistance and support get broken or breached. And a new level of resistance and support are identified based on how the price will move. In many instances, the previous resistance level becomes the new support zone when the price moves upwards. If the value is trending downwards, then the old support zone will become the new resistance area.
Sometimes, the price may go slightly lower or higher than the resistance and support zones but will quickly return to its usual trend. In cases like this, the resistance and support areas are not broken but only pierced. So, there is no need to identify a new resistance zone and support zone.
Resistance zone and support zone are vital for forex traders for three reasons.
- Spot possible reversals. When a currency value reaches a specific range in an upward trend, it will have to go down at some point. The reverse is also true with forex trading. A currency value that goes down must go up at some point.
Remember Newton’s law of gravity? It states that an object that goes up must come down. It is a lesson that is not only useful in the classroom but also in forex trading. Through the support zone and resistance zone, you can predict when a reversal is likely to happen. And at what level.
It is helpful when you have been on the losing end of a forex trade transaction.
- Trigger for entry and exit points for trades. It is good to observe the charts and to know the highs and lows. But putting it to use is another thing. An entry point is your starting point in forex trading, where you buy a currency pair at a specific value. The objective is to get profits by selling this currency at a higher rate later. But you will not gain profit every time. Sometimes, it’s acceptable to settle for the same value.
What you don’t want to happen is to be on the losing end where your selling rate is lower than your buying rate. When you sell your position, you are exiting the trade. Resistance and support help you to identify when the best time is to buy a currency. And the best time to start selling.
- Determines stops in forex trading. An experienced trader knows that risk management is needed to be successful in forex trading. You will lose money as you go about your trading transactions. That is the truth. Even the best forex traders in the world will lose money in some trades. But by putting an effective risk management strategy, you can cut the losses. After all, forex trading is risky.
Only one out of three traders will gain profit. So, how do you create a risk management strategy? First, you must know how much money you can afford to lose. Think of absolute numbers. Is it $100 or $1,000? Most professional traders say that you must not risk more than 1% to 2% of your total deposit. For example, you have a $10,000 forex trading account balance. If you follow the 1% rule, then your maximum is $100 per trade. Or, if you are more confident with your trading skills, you can start at 2% or $200.
Never trade more than this amount, or you will end up losing all your account balance in no time, especially if you lose many times in quick succession. Imagine if you risked $1,000 per trade and you lost ten times. You will have zero balance by the end of the day!
The second way to manage your risk is by putting a stop-loss order. It is an instruction from the trader to the broker to close a transaction that reaches a loss level. For example, you are keeping a position in the EUR/USD at $1.3 to one Euro. You put a stop-loss order at $1.1 to one Euro before you go off to play golf. It means that when the Euro losses $0.2 value against the dollar, the broker automatically sells your position.
It will keep you from losing more money should the exchange rate be favorable to the dollar. Resistance and support can help you identify the exact value where to set your stop-loss order. Usually, traders activate the stop-loss order a few pips from the level of support.
How do you identify resistance and support?
Now that we know what resistance and support are in the context of forex trading, we can discuss how to identify them. Some items to watch out for are getting the wrong levels and identifying too many resistance and support points. You want to make your chart clean and readable every time.
There should not be any doubts that a particular level is a support or resistance zone. If you have doubts, remove them from your chart. You only want to see the resistance or support levels that will affect your trading decisions. Here are some tips on how to draw them on your currency pair charts.
- Zoom out your charts. Resistance and support come from historical movements in the value of currencies that get paired. And when you talk about historical data, the more data points you have, the better the analysis will be. You can look at the performance of currency pairs per minute, per hour, or month. Whichever you choose, get more periods so you can get more resistance and support levels.
Zooming out on your screen will allow you to take a big picture of the technical analysis data. It will also prevent you from making sweeping conclusions based on recent data alone. You already know that a lot of external factors affect the value of a currency. A price movement might be because of artificial factors or a short-term interim policy by the central bank. So, it is best to look at longer times with more data points to establish stable patterns and trends.
- Draw the most obvious levels. As we pointed out earlier, a clean chart will allow you to make better decisions. There is no point in drawing many lines in one currency pair chart only to be overwhelmed by the volume of data later. We know this condition as overthinking or analysis paralysis. It is a situation viewed as too complicated due to the consideration of a lot of things. The result is that no decision or action gets done. In forex trading, analysis paralysis can happen when you look at many technical indicators such as many resistance and support zones to the point of being overwhelmed. And most of the time, these areas are close to each other.
You no longer know where to start. All the data don’t make sense anymore. So, limit the resistance and support levels that you will highlight in the chart. Choose the highest and easily recognizable peaks and drops. And look for quality more than quantity.
- Aim for the most touches. By now, you have already plotted the most dominant resistance and support levels. The next thing to do is to identify the absolute value of the peaks and drops.
Since these two technical indicators represent a range of data or a series of numbers, it is impossible to use them in actual forex trading. For example, the support zone for the EUR/USD based on the currency value chart is between 1.2345 to 1.2500. At what point do you put the stop-loss order? Is it at the starting point of the support area at 1.2500? Or at the bottom of the range at 1.2345? Or maybe somewhere in the middle? Instead of guessing the number, you can use the point where the most touches happened.
Not only for that specific data but for the extended period in the trading life of the currency. If the recent 24-hour data shows prominent support at $1.2400 and past week data shows $1.2385, and still the past two months at $1.2390, you will have a support level very close to each other. So, you can adjust the line to the point where the three data points will be nearest to each other. Or where the three numbers will “touch the line.” In this example, you can choose $1.2385. It is a common point since the first two numbers already touched this line and exceeded it by a small margin.
Do not be afraid to adjust the support or resistance line. The objective is to get the exact number where the most touches happened.
In addition, traders use the concept of the trendline to highlight the direction of the trend. It is a line that links two or more lows or two or more highs with the lines drawn out in the chart.
The trendline is valuable in predicting how the currency value will be moving at a future time. It can move upwards to show an uptrend or downwards to form a downtrend. You will readily identify a trendline from the actual value of the currency from its shape. A trendline will be a horizontal or slightly curved line.
Currency values are candlesticks, or when zoomed out, like zigzag or spiked lines. As a best practice, there are three guidelines that you must remember when drawing trendlines. These are just some examples of how to use trendlines. There may be other effective ways to interpret data. It is vital to do your research to compare how traders make sense of the trendline.
The first guideline to remember is that a trendline connects a low swing to another low swing. Or a high swing to another high swing. Never link a low swing with a high swing since that will result in a broken trendline. How can you use this trendline in trading? It can be a trigger for future trading transactions. When a price hovers near the trendline, it is a signal to enter a trade. You can automate this through an entry order. It is an instruction to your broker to automatically buy a currency on your behalf when it reaches a particular price.
The second guideline is to look for a trendline with more than two connecting points. The principle is the more points linked in the trendline, the better. A bounce always follows a valid trendline. It is something attractive to traders, and they will rally behind it. From a technical point of view, the third point in your trendline makes it stronger or solid. It will eliminate doubts about whether a trendline is valid or just potential and artificial movement.
Third, the trendline is your helper to get profits or reach your financial goals. You might have heard the famous saying in trading that it is better to trade with the trend. As simple as it sounds, it has proved valuable for most traders. For example, you see a downward trendline or a bearish trend in the AUS/USD currency pair. If this trendline has three or more points, you should start to look for selling opportunities. But, if the trendline is moving up or showing a bullish trend in the same currency pair, you should look for buying positions.
How do you calculate forex support and resistance?
There is a more scientific way of determining forex support and resistance levels. It involves the use of a pivot point. What is a pivot point? It is the average movement of the price of a currency for a given day or week. The pivot point can also mirror a change in the market sentiment and determine holistic trends in each time frame. It considers three factors: the high, low, and closing prices between trading days.
A trading day can use any time frame, depending on what type of forex trader you are. If you are a day trader, the pivot point will be the recent day or yesterday’s data. If you are a swing trader, you can use pivot point for last week’s results. And if you are a position trader, you can use data from the past month. For now, let us look at yesterday’s result since most forex traders are day traders.
Forex is a 24-hour trading market, and trading happens anywhere in the world. So, what do you use to determine the high, low, and closing prices? While the forex market is decentralized, most traders use the closing time of New York, USA. It is the previous day’s close. It is at 5 pm EST time. Using this time zone will help you look at the same data as anyone else does. Consistency and uniformity are the names of the game.
The pivot point is a mathematical computation of forex support and resistance. The formula used is as follows. The pivot point is equal to high plus low plus close, all over three. It can be expressed as: PP = (High + Low + Close) / 3.
Once the pivot point or PP is known, you can readily compute the support and resistance values. Here are the derivative formulas.
- Resistance 1 or R1 = (2 x PP) – Low
- Support 1 or S1 = (2 x PP) – High
- Resistance 2 or R2 = PP + (High – Low), or (PP – S1) + R1
- Support 2 or S2 = PP – (High – Low), or PP – (R1 – S1)
- Resistance 3 or R3 = High + 2(PP – Low), or (PP – S2) + R2
- Support 3 or S3 = Low – 2(High – PP), or PP – (R2 – S2)
If math is not your favorite subject, there is still hope! The trading platform of your broker should automatically compute these levels for you. If you don’t have a broker yet, you can find many charting software online. Choose from a secure site and a reputable source. If you can find a tool from regulated brokers, that will be your best bet. It assures you that your money and identity are protected. And that they follow strict regulatory standards on trading and funds management.
To be sure, there is no exact way to determine what will happen on the next trading day. No one can tell the future with 100% accuracy. Not even a forex robot or AI system, with the most advanced computer system, can predict future trends in forex. Also, remember that the forex market is affected by unforeseen market forces. These can swing the value of a currency up or down. It includes central bank policies, economic indicators, political changes, and environmental or health concerns.
The law of supply and demand and the sentiment of traders also impact the price of a currency pair. But the pivot point and the three levels of support and resistance outlined above provide a solution with a high probability rate. To test this statement, professional traders and forex instructors have used live examples. They tested it on the Euro in 1999 with encouraging results.
It revealed that the value for the first support and first resistance levels are accurate, with only one pip difference from the actual day numbers.
What is support and resistance in a trading chart?
Support and resistance are points used to predict where the value will likely rally up or down. It uses past data to project future events. Support happens when falling prices stop at a particular point and change their direction. It will then begin to rise again. It is known as a floor since it supports or holds up prices and represents the point where the value will bounce up. Resistance is the opposite.
It takes place when rising prices stop at a certain level and change their direction. It will then begin to fall. It is also known as a ceiling since it prevents values from rising higher.
Can you trade with just support and resistance?
Yes, the basic concepts of support and resistance will give you a measure of skill and confidence to start trading. Some traders have testified that they gained some profit by just using support and resistance methods. But this cannot give you a guarantee of profits. And certainly not consistent month-on-month gains. Support and resistance are part of technical analysis. It is but one of the different strategies that you can use in forex trading.
Other methods like fundamental analysis are also producing successful traders. And it helps to learn the other strategies to make your holistic forex trading plan. There is no one size fits all formula for successful trading. You must develop this on your own. Practice, practice, and practice some more. And continue to learn and improve your trading skills by observing professional traders. Also, take advantage of the lessons from different brokers to get gems of wisdom as you venture into the world of forex trading.