Support and resistance is one of the most popular technical analysis forex trading strategies. Take a look at any currency pair chart and you’ll see prices that move up and down, seemingly in a random manner. But take a look closely and you might notice that prices never seem to go above certain levels or drop below certain levels. This forms the basis of support and resistance.
If you’re familiar with the theory of supply and demand, you’ll know that when there is a lot of demand, prices start to go up until a point where buyers feel the price is too high and demand starts to drop. Conversely, when there is a lot of supply, prices drop until a certain point where the low prices become unsustainable and start to go back up. Support and resistance in forex trading is based on the same principle.
The support is the floor on the graph which is a level that the price never seems to fall below and the resistance is the ceiling on the graph which is the level that the price never seems to break through. The more times the price is unable to break through the floor or ceiling, the stronger the support and resistance is said to be.
In order to project the support and resistance levels, first find on the chart key positions where prices refuses to break through and changes to a reverse direction. The prices will either go up to that position then bounce down or drop to that point and reverse up. Take a ruler and draw a straight line through all the support points and another line through all the resistance points. If the points don’t form a straight line, then try to hit as many points as possible or imagine a straight line forming between the points. This is where technical analysis is as much an art than a science.
It’s normal if the 2 lines are not parallel or seem to be trending up or down. The area between the 2 lines is called the price channel where prices seem to bounce up and down. While this doesn’t happen all the time, traders who use the support and resistance strategy simply expect prices to reverse down when approaching the resistance or reverse up when approaching the support level.
It is important to note that while support and resistance is a very popular strategy, there are instances where prices break out of these levels. This could be based on economic news releases, rumors and for no perceivable reason. There is no forex trading strategy that works 100% of the time and this is no exception.