What Is Support And Resistance?
Support and resistance levels form part of the cornerstone of technical analysis. The basic idea with support and resistance is that we are looking to identify areas where price is likely to stall and possibly bounce (support levels) and areas where price is likely to stall and fall back from (resistance levels). Necessarily, support levels are identified as levels below current market price and resistance levels are levels sitting above current market price.
Lets take a look at an example to make this clearer.
In the chart above we can see the EURJPY on a 15-Minute chart. We have marked two horizontal areas, one labelled Resistance (where we can see price trades down from) and one labelled Support (where we can see price bounces from). So in it’s simplest form, finding Support and Resistance levels is simply a case of finding clear highs and lows on the chart where we expect price to reverse. It’s an incredibly simple method for identifying possible areas to trade but a lot of Forex pro’s use these areas to buy and sell and for good reason.
What actually causes support and resistance levels to work?
The driving force behind the price action we see on our charts is order flow. Order flow in the markets determines the course of price. This is the reason why support and resistance levels tend to be so effective, due to the accumulation of orders at these levels.
Lets take a look at that example again and break down what is actually happening at those two important levels.
So you now you can start to understand support and resistance as more than seemingly hard-to-pick lines on a chart, but as important order flow levels.
The key thing is to always think of them as “areas or levels” instead of simply a specific price.
Orders will cluster at these levels and so that is why sometimes price doesn’t respect the level to the pip but moves through it slightly before reversing. The levels remain in play until the supply/demand balance shifts at that level and price breaks it properly.
Once a level is broken and we know that the supply/demand balance has shifted at that level, the level then changes, so a broken support level becomes resistance and a broken resistance level becomes support.
Lets take a look at an example to understand this concept more clearly. We’ll take a look at this integral order flow dynamic playing out on a much higher time-frame to make it really clear to visualise.
In the chart above we can see AUDJPY on the weekly time-frame. Can you see how important that one price band has been since 2007? it’s incredible isn’t it? That one price band acted as support for nearly two years, it then held as resistance for three years and has since held as support for three years all simply down to the changing nature of the supply/demand order flow balance at that level.
Hopefully you can see just how valuable support and resistance levels can be to your trading. Building support and resistance trading strategies is a great first step in learning to trade using technical analysis and if you are just starting I suggest using the higher time-frames to begin with, as the reduced noise makes the key levels far easier to spot.
Once you start to combine tool such as price action and technical indicators with these levels you can quickly develop some really great trading strategies which we will take a look at in another article.
Spends some time practising with support and resistance levels and you will quickly develop the knack of identifying the key levels. A nice practice method to use is identify key levels for the week ahead and then note down how price reacted at the levels you identified. Keep a record and over the weeks you will improve drastically this way.