Length : 3.30 Minutes
What is Support and Resistance?
In technical analysis support and resistance is one of the most widely used concepts. Many traders observe these support and resistance levels for potential trade setups.
Support is a price level where a downtrend can be expected to pause due to a concentration of demand. As the price of a currency pair drops, demand for that specific currency pair increases, thus forming the support zone.
Meanwhile, resistance zones arise due to a sell-off when prices increase. To put it differently, resistance is the price point at which the rise in the price of a currency pair is halted by the emergence of a growing number of sellers who wish to sell the underlying currency pair at that price level.
Generally speaking, market has proven over the years that the more often price tests a level of resistance or support without breaking it, the stronger the area of resistance or support is.
However, bear in mind that as a price reaches a point of support or resistance level, it could either respect the zone and bounce back or violate it and continue in its direction till it reaches to the new support or resistance level.
In addition, support and resistance levels have a tendency to form at around round numbers. This attribute is due to psychological aspect associated with the round numbers, most of the traders pick their support and resistance levels at around round numbers.
Identifying these levels not only could help to eliminate bad trades as they could potentially point out oversold and overbought zones, but also could be used for identifying good entry and exit price levels if used in conjunction with other related indicators.
Below are two examples to illustrate the use and the significance of the support and resistance in technical trading.
In the NZD/CHF chart above, the power of resistance can be clearly observed that the price has tried to reach and break through more than 5 times but the resistance level has hold up strong. This is a great opportunity for a sell setup near the resistance level after the second or the third touch. As always, it is advised to confirm with another indicator in order to assure that the resistance level is strong to hold up. And in this case we have Relative Strength Index (RSI) indicator, which also giving overbought signals and confirmation to sell. This is a great trade setup as you can short the market at least three times before the resistance level is penetrated.
The EUR/AUD chart above is another example of support and resistance. Notice that just like the previous example the price has touched the support level more than five times, and at the same time RSI is signalling the existence of the oversold condition right around the support level. Thus, there are opportunities to buy around the support level. In addition, as you can see once the support level is violated and price has broken through, the level changes its role and serves as resistance.
In general, support and resistance level can not be ignored regardless of the strategy used by traders. They are one of the most effective technical strategies, and identifying the important support and resistance levels and using them in conjunction with other technical tools could generate high quality trade setups with great potential return.