Support and resistance levels act as a zone through which traders can determine entry and exit points. Forex traders use support and resistance levels on charts to identify a continuation or a reversal of a current trend.
Defining support and resistance
Support is a price level where the market downtrend pauses because of an increase in demand. Buyers push prices as the demand increases, creating a floor-like structure is created.
Resistance is a price level where the market uptrend stops because of high supply, creating a ceiling-like structure.
When the price reaches these support and resistance levels, two things could happen;
- Either the price reverses from these levels
- Or it continues to move in its current direction until it crosses above or below the support and resistance levels.
In other words, imagine that the market price is a ball bouncing between the floor and ceiling. When the extra force is applied, the ball touches the floor or the ceiling; it creates a greater impact. This is exactly how the bulls/bears work between the support and resistance levels.
Trendlines
An understanding of trendlines helps traders use support and resistance levels effectively. A trendline is a line that a trader draws on a chart to connect a series of price levels of a currency pair. On the chart, the price makes several peaks and troughs.
When peaks are connected, they form an upper trendline, and when the troughs are connected, a lower trendline appears. In this way, the trendline acts as an identifier of uptrend or downtrend.
Using support and resistance levels
Support and resistance levels can be used, supported by trendlines.
When the market is going upwards, resistance levels form, and the price moves back towards the trendline. Whereas, when the market moves downwards, support levels occur, and the price moves up to the trendline.
According to historical analysis, when the price makes support levels at the trendline, it prevents the price from further declining, and this principle applies to longer timeframes as well.
Other ways to use support and resistance levels are through indicators. Moving averages are a well-known identifier of support and resistance levels. Moving averages smooth the historical price data and predict future price movements.
Traders can use moving averages to pinpoint support and resistance levels, selecting their entry and exit points. Another indicator traders can apply to find support and resistance levels is Fibonacci retracements. It identifies short-term market movements on a scale of 0 to 100. It creates dotted lines between 0 to 100, fitting support and resistance levels.
Several other methods can be applied to identify support and resistance levels, like Camarilla Pivot Point or Elliot Wave principle.
Key takeaways
- An understanding of support and resistance levels is crucial in trading and market analysis
- The support level is considered a floor under trading prices, and a resistance level is the ceiling
- Using support and resistance levels, traders can foresee an asset’s price moving in a particular direction