Every trader would like to know the future. Imagine: you can see exactly where the price is going to go and you plan your actions accordingly. Sounds good, doesn’t it? Well, time travel, even virtual, is not a thing yet. But you know what is? Market analysis. Studying the past chart data to predict the upcoming events comes in many forms and shapes. Today we are going to focus on one of them. Here is all you need to know about support and resistance levels in Forex trading.
What is Forex market analysis?
To fully understand what is support and resistance on Forex, let’s first take a look at the price movement in general. It’s true that your very first glance at the chart will be confusing and maybe even a little scary. For an untrained eye the graph looks random and complicated. However, the more time you spend analyzing the market, the more sense it will make. Some experienced traders even say that there is a certain charm to the way price value fluctuates on Forex.
Market analysis divides into the technical and the fundamental one. Technical analysis looks at dry data such as specific prices at the specific times. Additionally, technicalists use a series of indicators and techniques to evaluate factors like volume, volatility, trend direction and strength and so on. All of these are believed to provide a solid amount of information to work with and build your future predictions based on them.
Fundamental analysis considers the technical data, but focuses more on the price-forming aspects that come from the outside. These will include social, political, economical events that have direct or indirect effect on the market. As you run fundamental analysis, you calculate the possible outcome of the event in question. For example, when a certain economical report is dropped, the market can be expected to have an escalated level of activity.
The majority of traders stick to only the technical analysis. However, the most successful market experts will always confirm that they are working with a combination of technical and fundamental data, while also considering the market sentiment to top it off. The combo of analytical approaches will usually provide you with a more detailed view of the situation and, therefore, give you more options in terms of your action plan.
But whichever analysis type you are choosing to go with - you’ll have to start with the basics. One of such is the skill of reading Forex charts. By mastering chart reading and learning about different concepts, such as support and resistance level calculation, traders gain an advantage of having a better idea on how to act.
You probably already know that there are three main types of charts used on Forex. There is a line chart, which displays a single broken line that connects together all the closing prices of a pair over the specified time period. Line charts are often used in combination with other types. The most common use of the line chart is trend observation and confirmation over long periods of time.
Then there is the bar chart, which goes into a bit more detail. Each bar represents both opening and closing prices, as well as the highest and lowest price points in the chosen time segment. The way every new bar is formed is pretty simple: top peak is the highest price, the bottom peak is the lowest, a marking on the left is the price at the open and the marking on the right - at the close. Bar charts are often used by price action traders due to their minimalistic and straightforward structure.
Candle charts follow the same logic as bar charts, but are considered easier to comprehend. Very obviously - they are the most popular chart type on Forex and many other markets. Candles consist of the same elements as bars: high, low, open and close. The main difference is the location of the open and the close will depend on which one was higher. If the price at the close was higher than at the open it will be represented by the top of the candle and vice versa. Plus the candles are conveniently color coded green and red (colors might be different depending on your MT4 personalization settings). The green will mark out the bullish candle, where the price went up and the red - bearish candles that represent the reduction in the price.
Understanding these basics is crucial to successfully reading the chart and extracting the necessary information from it. The more skilled and knowledgeable a trader becomes, the more they notice specific chart patterns, price corridors and levels of support and resistance.
One of the basics of technical analysis is that the currency exchange market is repetitive and tends to run in patterns. Your job is to basically find a right wave to catch and get on and off it at the proper moment.
The uniqueness of this process is that the price can be both predictable and chaotic. A factor referred to as market sentiment is a reflection of how the traders are feeling about the situation and what decisions they tend to make. From this we can conclude that the market is largely driven by its participants and that they can significantly contribute to the chaos.
Good news is that Forex traders have their own ways of finding a structure within chaos. One of these ways is determining the levels of support and resistance. Locating these levels can help predict the upcoming moves of the price, plan the most optimal spots for exits and entries and suggest the most effective risk management tactics.
So what is the logic behind support and resistance level calculation?
As you might have guessed from the name, support and resistance are limits that contain the price movement. Support is at the bottom of the chart as it “supports” the price by not letting it go below too much. While resistance is at the top, limiting the upward movement. It is important to mention that those levels are virtual and not something that is set in stone. Meaning that traders can calculate them in a variety of ways, and they won’t always be correct.
The way support and resistance levels act is by having the price bounce off them and go in the opposite direction. Sometimes the price can reverse without reaching any of the levels and sometimes it will break through them. So here are our takeaways at this point:
- Support and resistance level determination can vary
- The support and resistance levels might not be true if calculated incorrectly
- The price will not always react to the levels - sometimes it goes past them
Traditionally the support and resistance level visualization is a horizontal corridor with the price always heading towards the middle mark. This can be called the standard or structural support and resistance, However there are also trend line support and resistance that are diagonally shifted in the same direction as the current trend and dynamic support and resistance that adjust to the price movement as it progresses and can resemble wavy lines.
The interesting phenomena of resistance and support levels is that in some cases one can switch into another. For example, the resistance that was established during an uptrend can later on turn into the support within the same trend. This can help a trader to see a bit further into the future and save time establishing the new levels. But then again, sometimes the price movement is so rapid and persistent that levels get broken through one after another. In such scenarios it is best to switch to trend line or dynamic levels of support and resistance.
One last note is that sometimes support and resistance can appear broken but in fact they aren’t. This can look like a wick of the candle reaching beyond the limit or even several candles formed outside it. But if the price still reverses and heads to the opposite side, the level remains the same. This way we can only say that the level of support or resistance has been broken, if the price didn’t bounce off it. Our takeaways are:
- Support and resistance can be horizontal, diagonal and dynamic
- Resistance can become support and vice versa
- The support or resistance level is only broken when the price didn’t bounce off
Next, let’s move on to some of the most common ways of finding resistance and support levels.
How to find resistance and support levels?
As we have previously discussed, there are a number of ways to determine where the levels of resistance and support are on the chart in front of you. Some of those ways are very straightforward, and others require additional tools and skills. So the real answer to how to find resistance and support levels is that it is up to you to choose.
Here we are going to list several most common approaches. It is worth mentioning that they have been tested by hundreds of traders and proved equally effective. This means that at the end of the day it is more about your preferences and overall strategy. For your convenience the following options are listed from very basic to more complex ones.
- The obvious. Everyone, and we mean everyone, can master this approach with implementing basic observational skills. Take a bigger time frame chart, for example 1 month. Sit back and take a good look for it. You are looking for high and low points that seem to be all forming at a certain invisible level. This does not mean you are looking for a perfect zig zag line. As we know, price always moves up and down forming a shaky graph. What you need are several highest swings up and lowest down. Here you go. These can easily serve as your levels of support and resistance.
- Trend lines. We have briefly covered this type of support and resistance levels, now let’s talk about the technicalities. The direction of a specific trend line is going to depend on whether the trend is heading up or down. An uptrend is defined by at least two consecutive higher highs (the next higher than the prior). By connecting these two with a straight line you get yourself an angled level of resistance, that might eventually turn into support, as we have discussed before. For better results, it is generally advised to use more than two peaks, especially in volatile markets when the new swing can have larger amplitude compared to the previous one.
The next several ways are going to be oriented at using support and resistance indicators. Indicators are add-ons to the chart that extract specific information and help traders to get a better understanding of the overall situation.
- Moving Average. Moving Averages or MA’s are widely used in Forex trading. The logic behind this tool is very simple - calculating the average values of a chosen asset over the specified time period. Moving Average can be used to get a better view of the market, evaluate trends, use in combination with other tools and more. Also, one of the ways to use MA is to look at it as a level of support or resistance. Depending on the timeframe you choose, you will need to select the appropriate period for the Moving Average. A period expresses the amount of time that is taken into consideration and the number that an average sum is going to be divided by. On smaller time frames it is very common to watch the price bounce off the MA several times.
- Bollinger Bands. BB indicator builds up from the simple MA and consists of three lines: top band, middle band and bottom band. The distance between bands is calculated using the formula for standard deviation. A principle behind standard deviation is purely mathematical. By evaluating the volatility associated with an asset in question, Bollinger Bands form based on a specifically set formula. In many scenarios, the bands can be looked at as pretty reliable resistance and support levels. You can learn more about trading with Bollinger Bands from a full guide, posted here in our blog.
- Fibonacci Retracements. Another popular way of incorporating math into trading is through the use of Fibonacci sequence. This sequence consists of a series of numbers that form on top of each other. There are many historical references to the Fibonacci sequence, one of the most popular ones is “the golden ratio”. But what does it have to do with Forex? Well as we have already said, technical analysis is not more than a way of interpreting numerical data. And since we are working with numbers, it is only logical that mathematical concepts easily apply. Moreover, many traders have confirmed the significance of specific Fibonacci numbers through several popular trading strategies. Most of these strategies are built on drawing the levels of support and resistance at certain distances from the ongoing price movement. And those distances are directly corresponding with numbers from the Fibonacci sequence.
There are many other ways to find the levels of resistance and support. In fact, if you keep trading long enough, you might even figure out your very own approach. It is important to remember, however, that no matter how effective you believe your technique to be, sometimes it won’t work. Simply because there are so many variations of how situations unfold at the currency exchange market, and they all require different treatment.
Now we are going to cover several support and resistance trading strategy examples. Same rule applies here - they are all effective, but not one hundred percent of the time. So try to be as cautious as possible, when considering a certain strategy and make adjustments when needed.
Adopting a trading strategy is crucial to trading success. Strategies tell us how, when and why we should act. Choosing a strategic approach is very individual, because all traders are different. Depending on your financial capabilities, availability, knowledge, skills and so on, you will be looking at a specific category of strategies and deciding on which one you want to go with.
Some strategies have to be followed religiously and some are mere guidelines for what you should be expecting. It sounds like a lot to take in, but the further you proceed on your Forex trading journey, the better understanding you will have about most strategies and how they apply to your case. Below you will find five support and resistance trading strategy examples that we see as reasonably effective and simple to follow.
Basic support and resistance trading price action strategy
Instruments (currency pairs): Any
Timeframe: Any, but at least 15 minutes
Trading sessions: Based on the instrument
This strategy is based on the so-called obvious way of support and resistance location. Look at the chart and identify the levels at which price reverses. Then draw to horizontal lines connecting the spots where the price hit that invisible barrier. Most traders choose to go with tips of candle wicks. Once these levels are defined, consider these.
To buy using this strategy, wait for the price to reach support. Then you can choose to place a buy stop 3 to 5 pips above the high of the candle that touched the support or set a buy limit order that will get automatically activated once the price reaches it. You also have an option to buy immediately at the current market price. Depending on the timeframe, set the stop loss 10 to 30 pips below the support line. Increase the pip count or larger timeframes. Take profit will roughly be at the level of resistance, it is very common to place it just slightly below the resistance level, this way guaranteeing the profit.
To sell, wait for the price to reach the resistance line and either place a sell stop 3 to five pips below the candle that touched the level or set a sell limit which will automatically activate. Just as with buying, you can also choose to sell immediately at the current market price. Similarly, stop loss will be 10 to 30 pips above the resistance level and you can adjust the pip count according to your own preference and specific timeframe. Take profit will ideally be located within the price corridor, closer to the level of support.
Keep in mind, that price is not always reacting to the support and resistance levels the way you expected it to react. So, watch out for the price breaking the level or false breaking it and use this strategy only when the reversal is confirmed. On the bright side, this approach is very straightforward and does not need any specific skills or tools to be effectively implemented. Remember that practice makes perfect and come back to this trading method frequently, even after you have mastered some complex ones.
Support and resistance switcheroo
Instruments (currency pairs): Any
Trading sessions: Based on the instrument
Another highly flexible strategy is based on the principle we learned about earlier: in some cases a broken level of support can become resistance and vice versa. You may ask: how do we know that this will happen? Well, we kind of don’t. But if you master recognizing and evaluating different chart patterns, you can look out for the reversal signs that will help you confirm that this strategy is right for your case.
To buy with this strategy, wait for the price to move back towards the resistance level it broke through. Similar to the previous strategy, you have three options here: place a buy stop 3 to 5 pips above the top of the candlestick that touched the level, set a buy limit 3 to 5 pips above the ex-resistance level or buy immediately at the market price. Stop loss location will depend on which option you chose to buy with. If you are using a buy stop, set the stop loss several pips below the candlestick that touched the level, 2 to 4 will do. And if you went with a buy limit or market order, stop loss will be between 10 and 30 pips below the ex-resistance level, depending on the timeframe. Take profit can be based on the previous significant high swing and the surrounding zone.
In order to sell, wait for the price to break the support and start rising back to it. Once again you have three options: a sell stop 3 to 5 pips below the candle that touched the level, a sell limit that is set 3 to 5 pips below the ex-support level or a sell at the current market price. Following the same logic as before, your stop loss for market order and sell limit will be from 10 to 30 pips above the broken support, depending on the timeframe. And for the sell stop the stop loss is 2 to 4 pips above the candle that touched the line. Take profit will be at the same level as the previous significant low swings.
This strategy, when implemented correctly at the right moment, provides a great risk to reward ratio. It is widely implemented by both professional and novice traders due to its simplicity and effectiveness. What’s more, this approach will be equally beneficial for short term traders as well as for the long term traders.
Support and resistance plus Bollinger Bands
Instruments (currency pairs): Majors
Timeframe: 1 hour or 4 hours
Trading sessions: Based on the instrument
Indicators: BB at default setting
We have already briefly covered how the Bollinger Bands indicator works, therefore the logic behind this strategy is very simple. In this particular method BB do not serve as the levels of support and resistance, but rather work together to provide a strong signal. Having the bands at the default setting provides the best result, however if you are experimenting with timeframes - feel free to adjust the BB as well. For this method to work you will need 2 conditions: price has reached the level of support or resistance at least twice and that same level crossed the upper Bollinger band. This will happen when the broken support turns into resistance or the other way round.
So, to buy using this method, ensure that the conditions are met: the resistance zone has been broken, the price reacted to it at least twice and it now works as support. Then you will need to wait for the price to head down to the lower band, which will be roughly in the area where the level has been broken. Set up a pending buy stop 2 or 3 pips above the candle that touched the lower band. Stop loss is 4 to 5 pips below the low of the same candlestick. You can take profit when the price reaches the middle band, or if you are feeling lucky, when it reaches the top band.
And to sell you basically do the opposite. Wait for the support zone to be broken and price reacting to that level at least twice. After the price got back up to the upper band, which is located near the zone of the broken level, set up a pending sell order 2 to 3 pips under the low of the candlestick that touched the band. Stop loss is 5 to 8 pips above the high of that same candle. Take profit at either the middle or the lower band.
Pin bar pattern plus support and resistance scalping strategy
Instruments (currency pairs): Any
Timeframe: 5 minute
Trading sessions: New York and London
Indicators: Pin bar indicator (optional)
For this scalping strategy you will need to find the levels of support and resistance and look out for the single candle pin bar pattern. Pin bars look very similar to hammers, the main difference is that hammers usually only have one long wick and small to none on the other side. Pin bars also have a long wick on one side, but they are also featuring a small to medium length wick on the opposite side. Pin bar is considered a stronger signal when it is a part of a three candle pattern, with long body candlesticks on both sides. If you are having trouble locating the pattern, you can always use an especially designed indicator to point it out.
To buy using this setup, establish your support level and wait for the pin bar candle to form near it. Place a buy stop 1 or 2 pips above the pin bar or buy immediately at the current market price. Stop loss is located several pips below the support level. Take profit when the price reaches at least two times your initial risk or choose to go along with the trend until it reaches the resistance.
To sell, wait for a pin bar candle to form near resistance and either place a sell stop 1 or 2 pips below the pin or sell immediately at the market price. Stop loss will be placed approximately 2 to 3 pips above the level of resistance. Same as with going short, exit when the price has reached at least twice your initial risk or when it went all the way down to support.
Just with any other scalping strategy, the main thing you have to account for is spread charges. Since we are aiming for very minimal profits here, the spreads can eat up a good portion of your gain. In order to optimize scalping, ensure that you have the best suitable account type with your broker and limit the amount of your trades, when you see that situation starting getting out of hand. Risk management is extremely important in all types of strategies, but in the fast-paces ones especially.
Gravestone Doji with support and resistance
Instruments (currency pairs): Any
Timeframe: Any, but at least 1 hour
Trading sessions: Any
Last but not least, we have this very simple strategy that is also based on pattern identification. Gravestone Doji is a pretty distinctive bearish reversal signal, when it is located at the top of the bullish trend. It forms when the open, close and low were at the same or nearly the same level. The high, on the other hand, is stretched out towards the top, pointing to the fact that the market is testing the potential resistance level. Since Gravestone Doji is a bearish reversal signal, we are assuming that the market is going to head down and therefore we are in the sell mode. The opposite of the Gravestone is Dragonfly, where the same rules apply in reverse.
So, in order to sell, wait for the price to start heading up towards resistance and notice if a Gravestone Doji forms. If this happens, set up a pending sell stop 2 to 3 pips below the Gravestone. In case the trend does in fact reverse - the pending order will automatically activate and catch it. Very logically, the stop loss is going to be placed several pips above the top of the Gravestone Doji. You can use the zone of the previous significant wing low in order to find the most optimal spot for an exit.
As you might have noticed yourself, support and resistance are somewhat basic and can be combined with many strategies and techniques. The real challenge for a trader is to figure out how to find resistant and support levels in the best available way? Once again, the answer is - practice and experience.
Consider trying out the methods described above in demo mode to see if they are what you need. Demo account is an exact copy of your actual live account, only trades are simulated and you don’t have to invest any money to trade. It can be a great tool for working out the basics, as well as complicated strategies and approaches.