This article looks at the role of resistance and support levels in the foreign exchange market.
In order to be an effective foreign exchange rates trader, you must have an understanding of all aspects in the foreign exchange industry. This includes concepts pertaining forex to different charts such as resistance and support. This is a simple enough topic, however can be rather complicated to the beginner trader.
What is resistance and support?
Traders will often hear about price movements approaching levels of resistance or levels of support. These support and resistance levels are the price levels or ranges of price levels that a currency does not generally go over (resistance) or go under (support)
A basic example of the support and resistance levels can be seen in the chart below. The support level is the price which is seldom fallen below, and the resistance is the price level that is rarely exceeded. If the currency price hits either level it meet and then reverse, at least for a short while.
Why do foreign exchange prices behave in this manner?
The main reasons why prices behave in this manner is supply and demand and trading psychology. When approaching support levels, the number of buyers will usually exceed the number of sellers on the foreign exchange. This will cause a rise in the currency price. However, at the resistance level the number of sellers will exceed the number of buyers causing a decline in the currency price. This can occur frequently in a range until new market material is available to shift the price to a new range in which a new resistance and support level will be established.
What about support and resistance role reversal?
When a resistance or support level is met and exceeded, the roles of resistance and support will flip. If the currency price heads below a support level then that level will become a new resistance level. Furthermore, if the price exceeds the resistance level then the resistance will become the new support level.
This role reversal generally occurs when a strong price has shifted the currency price to a new range, usually caused by major global influences and economic reports. The chart below illustrates a role reversal where the dotted line represents a resistance level. However, when the price exceeded the level heading into a new range, the old resistance become a new support.
Support and resistance analysis on the foreign exchange market
The analysis of support and resistance levels is important to understand as part of technical analysis. These levels are viewed as essential aspects of trends and are used to make trading decisions, as well as identify when a trend may reverse. The levels can sometimes assist a trader in establishing a good trade over a bad trade.
For example, if a particular price level is reached, the trader may wish to take profits as he knows the price level rarely rises beyond that resistance point. Conversely, the trader may identify a support level and use the information to identify an appropriate entry point to a trade.