Support and resistance lines are the most simple form of technical analysis.
Traders identify support as prices where a currency pair is likely to rise in value. Traders identify resistance at prices where a currency is likely to fall in value.
Let’s get the basic understanding out of the way before moving forward:
In the diagram above, you can see that support lines are drawn where the currency pair tends to rise. A resistance line is drawn at a price where the currency pair tends to fall.
When price hits resistance, sellers enter the market, and previous buyers sell their positions. When the price hits support, short-sellers leave the market and sellers turn into buyers.
The result is a reversal in the movement of the currency pair.
Drawing Support and Resistance Lines
Support and resistance lines are best understood as areas on a chart rather than perfect lines. New traders often confuse support and resistance as being perfect, when it is very much an inexact science.
A currency pair can fall below a support line before rebounding, just as it can rise above a resistance line before falling. For this reason, traders should look at a support and resistance line as an area, and not a perfect point on a chart.
Take a look at the following chart:
We see that the price fell modestly below support. In the grand scheme of things, the very small dip below support is hardly reason to give up on this being a support line.
Now look at the whole of the chart:
As you can see, the chart did break support, but in the long-run, the price rebounded nicely and traders who treated support as an “area” rather than a fine line stood to make a large profit!
Finding Support and Resistance
When we talked about the different types of charts, we mentioned that line charts weren’t necessarily the best type of chart to pick because they don’t reflect the highs and lows at certain points. However, line charts are good for finding areas for support and resistance.
Take a look at this line chart:
Now compare it to this candlestick chart:
As you can see, line charts help us filter out the noise in the chart to find broad areas of support and resistance. The support and resistance lines found in the line chart did apply to the same data represented with a candlestick chart. However, the line chart helped us to better identify support and resistance because we did not have all the data.
There are a few other peculiarities you should know about support and resistance:
- Support and resistance become stronger with confirmation. When prices bounce off support, that support line is now stronger as traders see its value as a support line. The same is true for a dip off a resistance line.
- Support and resistance lines can flip-flop. If prices move sharply through a support line, the support line often becomes a resistance line for a future movement upward. Likewise, if prices move sharply through a resistance line, the resistance line will become a future support line for the new higher price.
- You can also use support and resistance to trade “breakouts.” When a long standing support or resistance line breaks, the move through the line will be very powerful. The strength of the breakout is determined by how long traders have used the level as support or resistance.
- Support and resistance often have fundamental reasons for being support and resistance. For example, traders with long positions in a currency pair may choose to set their “take profits” at 1.5000, which is an “even” number. Therefore, traders have put a lot of orders in to sell at 1.5000, so 1.5000 may act as a strong resistance line. This is known as “psychological resistance.”
In the next lesson, we’ll focus on the diagonal support and resistance lines, known as “trend lines.” Proceed to the next article.
