Support and Resistance Levels

Understanding this topic requires that you are already familiar with the three different types of charts which are the line, bar and candle sticks. 

Any of these charts can be used to determine the area or levels of the support and resistance.

If you are a newbie then I suggest using the line chart because it is a lot easier to plot and determine the levels. 

Now, to layout the area of support and resistance on your chart you have to define the part where the prices often bounces or reverses back on the opposite direction. 

When this occurs on the high prices then this level is called the resistance. Low prices formed at the bottom are the support level.

The lines that you have formed will act as your basis on deciding your target profit or stop loss. Your target profit is best placed before the support and resistance of the current market trend. 

The stop loss should be placed after.

What causes the resistance and support levels to be formed?

These levels or price areas are when the currency being traded on the market has been sold or overbought. This means that the number of sellers or buyers has exceeded the opposing side. 

When the trend of the market is continuously moving on the downward direction and the condition of the currency is already oversold then there’s a very high probability that the trend direction will go bullish. 

If the market is trending on an upward direction then suddenly you have found out that it is nearly overbought, chances is that the trend will go bearish.

There are several indicator tools that you can use to determine whether the currency that you trade are nearly overbought or oversold. 

One of this tools that I often use is the RSI. When the currency price is above the 50 level then the condition is overbought. Below the level signifies the oversold condition.

Support and Resistance Line

Combining the method of plotting the support and resistance lines on your preferred type of chart along with your overbought and oversold analysis will provide a high probability of acquiring a profitable trade. 

Support Levels

Support levels are levels where the price of a currency pair tends to stop falling and starts to move up again. 

These levels represent a price point where there is enough demand for the currency pair to prevent the price from falling further. 

There are different types of support levels, including historical, psychological, and trendline support levels.

Historical support levels are price points where the currency pair has previously bounced off before moving up. 

These levels are significant because traders expect the price to bounce off them again. The more times a price level has acted as support in the past, the stronger it is considered to be.

Psychological support levels are price levels that are significant because they represent a round number. 

For example, if the EUR/USD currency pair is trading at 1.2000, the level of 1.2000 may act as psychological support because traders may expect the price to bounce off this level.

Trendline support levels are levels that are formed by drawing a line connecting the lows of the price. These levels are significant because they represent the trend of the price movement. 

If the price moves up and touches the trendline, it may act as support and bounce off it.

Identifying support levels is important because they can provide traders with an indication of when to enter a trade. 

If the price of a currency pair is approaching a support level, traders may expect the price to bounce off that level, providing an opportunity to enter a long position. 

In addition, support levels can also be used to set stop-loss orders, helping to manage risk.

Examples of support levels in forex charts include the 1.2000 level in the EUR/USD currency pair and the trendline support level in the USD/JPY currency pair.

Resistance Levels

Resistance levels are levels where the price of a currency pair tends to stop rising and starts to move down again. 

These levels represent a price point where there is enough supply for the currency pair to prevent the price from rising further. 

There are different types of resistance levels, including historical, psychological, and trendline resistance levels.

Historical resistance levels are price points where the currency pair has previously bounced off before moving down. These levels are significant because traders expect the price to bounce off them again. 

The more times a price level has acted as resistance in the past, the stronger it is considered to be.

Psychological resistance levels are price levels that are significant because they represent a round number. 

For example, if the EUR/USD currency pair is trading at 1.2000, the level of 1.2100 may act as psychological resistance because traders may expect the price to bounce off this level.

Trendline resistance levels are levels that are formed by drawing a line connecting the highs of the price. These levels are significant because they represent the trend of the price movement. 

If the price moves down and touches the trendline, it may act as resistance and bounce off it.

Identifying resistance levels is important because they can provide traders with an indication of when to exit a trade or enter a short position. 

If the price of a currency pair is approaching a resistance level, traders may expect the price to bounce off that level, providing an opportunity to exit a long position or enter a short position. 

In addition, resistance levels can also be used to set take-profit orders, helping to manage risk.

Examples of resistance levels in forex charts include the 1.2100 level in the EUR/USD currency pair and the trendline resistance level in the USD/JPY currency pair.

Trading Strategies using Support and Resistance Levels

There are several trading strategies that use support and resistance levels. These strategies include breakout trading, bounce trading, and range trading.

Breakout trading involves waiting for the price to break through a support or resistance level. 

When the price breaks through the level, it is an indication that there is a shift in the supply and demand dynamics. Traders can enter a long or short position depending on the direction of the breakout.

Bounce trading involves buying or selling the currency pair when the price bounces off a support or resistance level. 

Traders can enter a long position when the price bounces off a support level or a short position when the price bounces off a resistance level. 

This strategy works well when the price is in a range-bound market.

Range trading involves buying the currency pair when the price is near the support level and selling the currency pair when the price is near the resistance level. 

Traders can profit from the price movement between the support and resistance levels. This strategy works well when the price is moving in a sideways or range-bound market.

In addition to these strategies, support and resistance levels can also be used to manage risk. Traders can set stop-loss orders below the support level to limit their losses if the price falls below the support level. 

Traders can also set take-profit orders above the resistance level to lock in profits if the price reaches the resistance level.

Examples of trading strategies using support and resistance levels include buying the EUR/USD currency pair when it bounces off the 1.2000 support level and selling the currency pair when it reaches the 1.2100 resistance level. 

Traders can also use the 200-day moving average as a support level and the 50-day moving average as a resistance level.

Common Mistakes to Avoid

There are several common mistakes that traders make when using support and resistance levels. 

These mistakes include over-reliance on support and resistance levels, failure to adjust support and resistance levels as market conditions change, and ignoring other important technical and fundamental indicators.

Over-reliance on support and resistance levels can lead to missed opportunities and losses. 

Traders should use support and resistance levels in conjunction with other technical and fundamental indicators to make informed trading decisions.

Failure to adjust support and resistance levels as market conditions change can also lead to missed opportunities and losses. 

Traders should adjust their support and resistance levels as market conditions change to reflect the current supply and demand dynamics.

Ignoring other important technical and fundamental indicators can also lead to missed opportunities and losses. 

Traders should use a combination of technical and fundamental indicators to make informed trading decisions.

Final Words

Forex support and resistance lines are important concepts in forex trading. 

Support levels represent a price point where there is enough demand for the currency pair to prevent the price from falling further, while resistance levels represent a price point where there is enough supply for the currency pair to prevent the price from rising further. 

Identifying these levels is important because they can provide traders with an indication of when to enter or exit a trade. 

Traders can also use support and resistance levels to manage risk. 

However, traders should avoid common mistakes such as over-reliance on support and resistance levels, failure to adjust support and resistance levels as market conditions change, and ignoring other important technical and fundamental indicators. 

By understanding support and resistance levels and using them in conjunction with other indicators, traders can make informed trading decisions and increase their chances of success in the forex market.