Support and resistance trading is a popular type of trading analysis that’s based on historical pricing. Traders in all markets, including the forex market, use this type of trading in order to find potentially profitable trades.
Support and resistance trading is ideal for specific types of traders and certain currencies; there are some strategies that work better with other forms of technical or fundamental analysis. Either way, it’s a good idea for a trader to understand the basics first, and to use this knowledge to augment their technical analysis skill-set.
Support and Resistance Trading: The Basics
Support and resistance trading involves determining a price point that the market generally attempts to sustain.
In simplest terms, this is the lowest point at which the price tends to fall and the highest point that the price tends to rise to.
In a simple support and resistance trading strategy, a seller will sell a currency that is currently above its “resistance” price (the highest price that it generally obtains) and will purchase a currency that is below its “support” price (the lowest price that it generally obtains).
The assumption is that the price will always go lower than the resistance price and remain above the support price, regardless of any other market variables. But that doesn’t mean that the support and resistance points always remain static.
Support and resistance points may drift upwards or downwards.
This is why support and resistance trading can be combined with other technical analysis methods such as moving averages. Regardless, the idea behind it is very simple: traders simply buy when the price is well below what it “normally” is and sell when the opposite is true.
How Does Support and Resistance Trading Work?
This type of forex trading sounds more complex than it really is.
Here are a few examples of support and resistance trading (though the numbers are simply offered as examples).
EUR/USD has always bounced back at 1.11 over the past six months. EUR/USD is currently at 0.99, so the trader now knows that it’s very likely that the support price is 1.11 and that the price will rise to at least that. The trader can buy EUR/USD intending to sell at 1.11 or above, if they feel confident.
average support level
Over the past six months, EUR/USD has bounced back at 1.11, 1.16, and 1.21. From this, the trader extrapolates that the support price is actually steadily rising over time. The trade is currently at 1.11. The trader can buy EUR/USD intending to sell at at least 1.21 or waiting until the next projected support price of 1.26.
support level climbing
The price of EUR/USD is currently 1.26. By reviewing the past six months, the trader sees that previously EUR/USD has encountered resistance at 1.18 every single time. The trader can now be very confident in deciding that the price will go down. They can then sell with the intent of buying once it’s fallen.
As you can see, support and resistance is deceptively simple. But that doesn’t necessarily mean that support and resistance strategies are.
Support and resistance strategies will vary depending on the length of time that is analyzed and the analysis of the actual support and resistance points. Support and resistance strategies can be fairly broad over a lengthy period of time or highly specific over a shorter one. It all depends on the individual trader.
Who Should Be a Support and Resistance Trader?
Support and resistance trades work best for traders who are interested in holding on to their trades for a somewhat significant amount of time — days rather than hours.
This is because the price needs time to normalize to its support and resistance levels. Support and resistance trading usually isn’t an optimal route for traders that trade quickly or intend to scalp. It is also ideal for traders that are working with major currency pairs. Exotic currency pairs are usually too volatile and unpredictable.
Stable currency pairs are the ones that will be most likely to show very clear support and resistance levels.
Support and resistance levels are also far more clear when there aren’t any significant economic problems that could be obscuring them. Support and resistance lines may be difficult to predict if there are current financial issues that one or both countries are experiencing.
Nevertheless, support and resistance trading can be excellent for a beginning investor, as it involves relatively simple technical analysis, is easy to understand, and can be done over a longer period of time.
Benefits of Support and Resistance Trading
- Reliability. Support and resistance trading is often found to be extremely reliable because it pulls from a significant amount of historical information. It may not see the most dramatic shifts in pricing, but it does create a fairly reliable trading strategy. The only issues with reliability encountered are usually based on volatility due to marked economic issues.
- Simplicity. It can be as simple or as complex as the trader desires. In simplest terms, it really only comes down to running an analysis on the historical prices of the currency. For beginners, simplicity can be very beneficial for both learning the basics of trading and still making reliable profits.
- Support. Support and resistance trading is exceptionally popular. Because of this, there’s a significant amount of support. Most of the major trading platforms include support and resistance metrics, and there are many tips, tricks, and tutorials available for those who want to learn more about this type of trading.
- Integration. This type of trading is not exclusive with other forms of trading. It can be readily used alongside other types of technical analysis, as a method of determining whether a trade is truly solid. This means that support and resistance trading will be beneficial throughout a trader’s entire career.
Getting Started With Support and Resistance
Like any type of technical analysis, beginning with support and resistance trading usually starts with finding a trading platform.
Many trading platforms are designed to already support this type of analysis out of the box.
Traders need to make sure they are matching their trading strategy with the right type of currency; support and resistance usually only works with major currency pairs, such as EUR/USD and USD/JPY. But traders don’t need to have a platform to begin analyzing their currencies. They can also simply analyze the charts themselves by looking for prices that have a “rebound” effect; areas where the price traditionally reverses.
It’s up to the trader whether they want to base their analysis on three months, six months, a year, or even more — though most support and resistance traders operate in time periods between three to six months.
Once the support and resistance levels have been identified, the trader will continue periodically entering in their trades as the price points go above and below these levels. The amount of profit the trader is interested in taking is directly related to the amount of risk that the trader is willing to accept.
Traders should still use take profits and stop losses to limit any of their potential risk. Conservative traders may capture their profits as soon as possible whereas more aggressive traders may want to wait until the current currency prices are well past their support or resistance levels.
Often, investors may use multiple techniques in order to determine and confirm their ideal trades — but it does take some work and practice. Traders that don’t have the hours to devote to learning the ropes can instead consider the use of forex trading signals.
Trading signals often use support and resistance in addition to other forms of analysis in order to distribute solid trading leads to their clientele, without any work having to be done on the trader’s side.