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Trading support and resistance levels in Forex

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by , 09-21-2011 at 03:32 AM (1679 Views)
Support and resistance is one of the most important price action tools in technical analysis. It helps an average trader to analyze all financial markets, not only forex. Personally, I have not used any technical indicators for a number of years in my trading and relied purely on support and resistance levels. I think this is due to the fact that those levels are psychological areas and most traders know that. That is why they usually stop trading when a price approaches important support or resistance level and watch price action there. Depending on what kind of traders they are they might try to trade a breakout or make a reversal trade.

Generally speaking support and resistance levels are areas where supply and demand meets. If price has been going up for some time and hitting a certain area jumped off it and was not able to break through, we would call that area resistance. And vice versa, if the price in any given currency pair was going down and suddenly jumped off a certain level and was not able to go down any further, we would call that area support. If price hits certain level several times and is rejected that level could be called very important support or resistance. Sometimes a price can be contained between support and resistance areas for many months until a break comes. So, every newbie trader should be concerned about those levels and study them on a daily basis, analyze them on charts and make trading decisions based on the conclusions made from those studies.

There are a few possibilities how these levels can be traded. I usually have two strategies to trade support and resistance. One is my range trading strategy and another is breakout trading strategy. When prices are in ranges for months and fluctuate between support and resistance levels I look for reversal patterns at the top and bottom of those ranges. Let’s say I studied my charts in eur/usd pair and decided that support for the pair is 1.3600 and resistance is 1.4300. Having this information I watch very carefully price action when the pair approaches 1.36 level. What I look for are certain reversal structures like 123 pattern, two support points that are usually made the same day and price is not able to pass through those points. I would also check some candle formations that would indicate to me that bears’ power is exhausted. Then I would probably place a limit buy order above that day’s high and would wait for it to be opened. If it is opened I just go with the market and move my stops accordingly.

Another way to trade these levels is to wait for a breakout. Although prices stay in ranges for a long time they finally break out and pairs start trending. The best way to trade a breakout is to place a limit order above the resistance and a support level and wait for the level to be broken. I also noticed that breakouts usually happen when there are some important news announcements, very often on Fridays. So, to filter some false breakouts you could wait not only for the level to be broken, but also try to combine fundamental news releases and technical trading. Place limit orders only when there is important news to be released. In this way the chances for a true breakout increase. When the order is opened, go with the market and move your stops accordingly.

See also:

Trend trading
What is MACD
Forex factory


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