Written by Robert McKinley

Support and Resistance

 

What are Support and Resistance?

Support

When see on a chart that prices are falling and then notice that when they reach a certain lower level, the price cannot seem to decline any farther, prices have reached a support level. Support is blocking the price decline.

Resistance

Conversely, when see on a chart that prices are rising and then notice that when they reach a certain upper level, the price cannot seem to advance any farther, prices have reached a resistance level. Resistance is blocking the price advance.

1. In a downtrend, price declines are blocked by support.
2. In an uptrend, price advances are blocked by resistance.
3. When price manages to break through resistance it can be expected to continue up to the next upper level of resistance.
4. If price manages to break through support you can expect it to continue to drop down to the next lower level of support.

In order for an uptrend to continue:

1. Each price thrust needs to continue upward through the level of resistance that stopped the previous price thrust.
2. Each price advance must finish at a higher support level than the previous price advancement.

In order for a downtrend to continue:

1. Each price thrust needs to continue downward through the level of support that stopped the previous price thrust.
2. Each price decline must finish at a lower resistance level than the previous price decline.

 

While support and resistance are widely used in Forex trading, not everyone agrees on just how to measure them. But before we elaborate on that, let’s see another way to look at them:

It is easy to see that price is, generally, moving up. It looks like a bull market. But we can also see that the price moves up only so far and then it hits a resistance point and then pulls back (declines). Each time it declines, though, it is stopped by a support level and then reverses again and starts back up again.

Of course something else is happening here as well; something important that we mentioned earlier. With each consecutive up-down-up cycle, both resistance and support levels are established at a higher level. With each upward thrust, the price breaks through the previous resistance level and establishes a new higher price point and, thus, continues its upward trend.

Simply reverse it for a downward trend.

Plotting Support and Resistance

First, you should know that support and resistance levels are not exact numbers. For example, when the market is testing price, support and resistance levels may appear broken. Candlestick charts usually indicate market tests with their shadows.

You can see that where the horizontal line goes across the chart (2500 resistance level) the upper shadows of the candles tested that resistance level. At that point, the market never broke the resistance. In the final analysis, it merely tested it.

How do we tell when support or resistance is actually broken?

There is no simple single answer to that question. Ask different Forex traders and you may get more than one answer. Some say that if the market price moves beyond a support or resistance level, then it is broken. However, others will tell you this answer cannot be correct.

Let’s take look at what happened in the above chart when the price did close above the 2500 resistance level:

Oops! It looks like the price closed above the 2500 resistance level twice but fell back both times. It was a “false breakout.” So, as you can see, caution is advised here. If you had “pulled the buy trigger” too quickly and bought this pair, you would have made a costly miscalculation. Not only was the resistance not broken; it actually strengthened some.

OK, now what can we do about this?

Well, it’s obvious that we need to somehow filter out false breakouts. The first thing is to think of support and resistance as “zones” rather than hard points on a chart. Here is where a line chart comes in handy. Remember, you can use a line chart to see only the closing prices instead of a candlestick chart, which adds extreme highs and lows – that for our purposes here can be misleading.

The reason candlestick charts can mislead us when we want to more accurately identify real support and resistance breakouts, is that sometimes what the candlesticks show us are “knee jerk” market reactions instead of clear, intentional market movements, which are exactly what we need.

Take a look at the line chart below and notice that horizontal support and resistance lines have been plotted across areas where prices have formed several peaks and valleys.

Of course nothing is infallible, but this is one way to more clearly plot support and resistance “zones.”

A couple of things to keep in mind:

1. When market price breaks through resistance, that resistance now becomes support.
2. Each time price tests a level of resistance or support without breaking through, the stronger that area (or zone) of resistance or support is.

 

The next lesson is Trends in Forex Trading

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