In this article, we’re going to show you the top 6 support and resistance tools.
We’ll explain what these levels really mean.
You’ll learn how to combine them with fundamental analysis.
And we’ll demonstrate how powerful this combination can be for your trading.
This article is broken down into the following areas:
- Understanding support and resistance
- 6 top support and resistance tools
- Tips for using support and resistance levels
- Combining fundamental analysis
- Trade example
Understanding Support And Resistance
These are psychological areas where price stalls time and again. Price then moves in a direction dictated by the market.
Price direction, after hitting one of these levels, is determined by two things.
What is driving price, and how strong the level is.
To find out what drives price, you need to know the fundamental reason behind each move.
Daily fundamental analysis will keep you in tune with the market. Keeping in tune with the market will help you determine what’s driving price at that time.
You can then decide whether to buy, sell or do nothing.
CMC Markets notes that strong support and resistance levels have the following characteristics:
– price reversed at these levels several times without breaking through
– large transactions occurred at or near these levels.
– round numbers overlapping these levels make them more significant
– the more recent a level has been rejected the more relevant it is
Other characteristics also include:
– levels identified on higher timeframes tend to receive more attention
– the longer a level is respected the more important it is
An example of this is a weekly level that’s rejected repeatedly. This is stronger than a level identified on a 1-hour time frame.
Different levels may also be used for different trading strategies.
For example, weaker technical levels on a short time frame are good for breakout trades.
What Do The Levels Mean?
According to Investopedia, the law of supply and demand is at the core of price movements. This includes both local markets and the global foreign exchange markets.
In FX, supply and demand levels are zones where transactions occur.
Support levels are created when price is falling.
IG explains them as levels the market doesn’t want price to fall below.
It’s where the balance of market participants shifts. In this case, the number of buyers outweighs sellers.
On an FX chart, price stops and hesitates at a similar level to the past. Then reverses or bounces upwards.
Support levels are where buyers feel a currency is fair value. There is demand for it.
Buyers may place new buy orders. And if those orders are triggered the price rises.
But sellers become cautious around significant support levels.
On the other hand, resistance levels are created when prices rise.
IG explains these as price levels the market is unwilling to surpass.
The balance shifts when the number of sellers outweighs buyers.
On an FX chart, price stalls at a similar level to the past. Then price often reverses, or bounces downwards.
Sellers become interested and may place new sell orders. If those orders are triggered the price falls.
But buyers become cautious around significant resistance levels.
They may take profit on existing long trades. And they may also wait for a new fundamental reason to keep buying a currency.
TheStreet highlights that technical tools such as support and resistance are self-fulfilling prophecies.
This is because many traders watch the same significant levels.
So, if traders expect price to stop and reverse at specific levels this usually happens.
Why Levels Break
Orbex offers two good reasons why strong levels may sometimes break.
Unexpected news is the first reason.
The central bank may do this if economic growth is stagnating and needs stimulating.
An interest rate cut signifies underlying economic weakness.
And an unexpected rate cut would surprise the market.
This would be a strong fundamental reason for traders to sell the currency.
And this is also strong enough to push price through a significant support level.
Price consolidation is another reason.
Sometimes price does not immediately bounce away from a strong level.
Instead, price may consolidate near the major level.
And the longer price consolidates the higher the odds of a price breach.
Any minor economic news or market sentiment could push price past the level. Especially if there are no major fundamentals to drive a price reversal.
A Reuters article shows a strong technical level being breached.
When this happens, price moves tend to be explosive. This is because many traders use these areas to define their trade risk.
They do this by placing stop loss orders around these levels.
So, if a strong support level breaks, many stop loss/sell orders trigger. This causes price to fall faster and further than expected.
The opposite occurs when resistance levels break.
It’s important to know that after price breaks a level, its role often reverses.
A previous support level becomes a new resistance level.
And a previous resistance level becomes a new support level.
6 Top Support And Resistance Tools
There are different ways to define support and resistance levels.
They all have their place depending on your trading strategy.
Here are our top six.
Horizontal Support and Resistance
First on our list is horizontal support and resistance.
They’re used to link where price has visited in the past.
Forexlive describes them as the most widely used support and resistance tool.
But, the levels can be subjective depending on the chart type you use to draw them.
Here’s an illustration of strong weekly horizontal support and resistance.
The levels behaved like price magnets, repeatedly.
First, price was drawn to the levels.
Then the levels behaved like a floor or ceiling.
And price bounced off them.
Price traded within the boundary of these levels. And respected them as far back as 2015.
Support and resistance levels provide a clear trading range.
So, traders buy and sell from these areas.
Trend lines and Channels
Next, we have trend lines and channels.
City Index describes them as an easy tool used to identify the direction of market trend.
And because they’re used to highlight trend, the lines are drawn diagonally on a chart.
If price is in an uptrend, the trend line slants up. And joins at least two swing lows.
But if price is in a downtrend, the trend line slants down. And joins at least two swing highs.
Channels are actually two parallel trend lines.
So, trend lines and channels also help define support and resistance levels.
But again, they can be subjective depending on the chart type you use when drawing them.
This daily chart gives a good illustration.
Price is in an uptrend and trades within the channel from May 2018 until September 2018.
Whenever price hit or came close to a trend line, it bounced away.
Price finally breaks out of the channel and lower trend line on 3rd September 2018.
This was much needed positive news for the UK. And strong enough for price to breach the channel.
Third on our list are Fibonacci levels.
They are ratios which follow a Fibonacci sequence.
They’re based on calculations invented by an Italian mathematician in the 12th century. His name is Leonardo Bonacci.
DailyFX explains how to draw Fibonacci retracement levels. They’re drawn from left to right where a swing move starts and ends.
Price usually respects at least one of these retracement levels.
CMC Markets states five popular Fibonacci retracement levels used by many FX traders. These are 23.6%, 38.2%, 50%, 61.8% and 76.4%.
And although 50% is not a Fibonacci number, it’s still a popular level.
Here’s an example.
The 38.2% Fibonacci retracement level acts as a strong resistance level.
And from May 2018 until September 2018 price tried to surpass this area.
But every time price got to this zone, it bounced back down.
Drawing Fibonacci levels is objective. And can be used on any time frame.
This is what makes them a popular tool for traders.
Next up we have pivot points.
They’re price averages of the previous trading session.
Pepperstone reveals their origins. Pivot points started in the trading pits of equity and futures exchanges.
To calculate daily pivots (DPV), you divide the high, low and market close prices by 3. This is elaborated by Babypips.
If price trades above the pivot point, it’s seen as bullish.
But if price trades below the pivot point, it’s more bearish.
There are other pivot points used for calculated resistance and support levels.
These are R1, R2 and R3. ‘R’ means resistance.
And S1, S2 and S3. ‘S’ means support.
Traders expect price to gravitate to these levels.
Pivot levels are popular because they’re calculated objectively. There’s no guess work.
If price breaks past the first pivot point, it’ll usually gravitate to the next pivot. And so on.
This makes pivot points good for short term trading.
In this 15-minute chart, price trades between the R1 and DPV.
The R1 pivot acted as resistance. And the DPV acted as support.
The pivot levels provided clear technical levels to trade.
Fifth on our list are moving averages.
Moving averages are also a popular choice for many FX traders.
They’re calculated by averaging the close prices over the last x-number of trading days.
An example of this is a 20-day moving average. This averages out the closing price of the last 20 trading days.
Moving averages follow price, so are created dynamically.
This also makes them good for identifying trending markets and determining momentum.
There are two types of moving averages.
Simple moving average (SMA), which is an average of a set time period. Each close price holds equal weighting in the calculation.
And exponential moving average (EMA). The most recent close prices are given higher weighting in the calculation.
Pepperstone explains moving averages can also be used as leading indicators. Market psychology plays a role in this.
This is because many traders use the same moving averages. So, a lot of transactions occur when price gets near these levels.
Here, the 50, 100 and 200 daily simple moving averages are examples.
Price gravitated towards each of them in turn. And used them as dynamic resistance levels.
The 200-SMA was the strongest resistance level because it didn’t break.
Followed by the 100-SMA, which received the most unbroken touches.
These SMAs interested traders because they provided the clearest opportunities.
But, price breached the 50-SMA more times than not.
So, the 200 and 100 SMA levels gave traders the best levels to sell and define trade risk.
Last but not the least on our list are swing levels.
According to IG, they’re created because price doesn’t move in a straight line.
And are very effective when price is trending.
Each time a swing level breaks, it creates a new level of support and resistance.
Here’s an example of daily swing levels.
Price is in a clear down trend.
So, the swing levels are created naturally.
They provide logical areas to buy, sell, define risk and take profit.
Tips For Using Support And Resistance Levels
Below we give 3 tips for using support and resistance levels:
Tip 1 – Defining and limiting risk.
A strong support or resistance level is one that price finds difficult to breach.
When price rejects a level, it increases the probability the same will happen again.
So, these areas become clear zones that you don’t expect price to break.
If it does, you accept you are wrong on that particular trade.
That’s why these levels are good areas to place a stop loss.
But since false breaks can occur, it’s best not to place a stop loss at the exact levels.
Instead, place your stop loss some pips behind the levels. They’ll act as a protective barrier for your trade.
However, if there are strong fundamentals, the level can be breached.
Tip 2 – Entering trades.
These levels are also good areas for entering trades.
You can identify the support and resistance levels on a higher timeframe.
Then drill down to a smaller time frame to look for a better entry.
Doing this helps you risk less pips while maximising potential profits.
And increases your risk reward ratio.
Tip 3 – Profit targets.
After you’ve opened a trade and price moves in your favour, at some point you’ll want to take profit.
And there’s a high probability price will be drawn to these levels. So, it makes them good profit targets areas.
But, it’s best not to use the exact levels as your profit target.
This is because price doesn’t always get to the levels before reversing.
So, place your take profit target some pips before the support or resistance level.
Don’t risk losing out on profit for the sake of a few pips!
Combining Fundamental Analysis
A ResearchGate publication reviews fundamental and technical analysis. And explains that both are decision making tools.
An article also demonstrates when fundamentals and technical levels are in sync.
So, for the best opportunity of success, first have a good fundamental reason to enter a trade.
Your trade reason will determine whether it’s a short or long-term trade.
Once you’ve done that, you need to decide a good place to enter.
Any of the above techniques can help identify good support and resistance levels.
And if a combination of technical tools highlights the same area, it’s more significant.
You can then open a trade in this area.
Define your stop loss in a protected place.
Or set your profit target before any major levels.
Forbes highlights the confidence traders get when fundamentals and technicals are in sync.
And the awareness it gives traders when they are out of sync.
Combining fundamental analysis and technical tools increases your chances of success.
Here’s a demonstration of combining fundamental analysis and technical levels successfully.
New Zealand’s economic data highlighted signs of weakness from Q4 2017 into Q1 2018.
Dairy milk prices were also falling. This is New Zealand’s main export.
These were not good signs for New Zealand’s economy. Nor its currency.
But despite this, NZD appreciated against the USD in Q4 2017.
The move up is highlighted by the first arrow in the weekly chart below.
But, this is the opposite of what you’d expect to happen.
However, during Q1 2018 price stalls at a strong resistance level. Price had also stalled here many times during the previous four years.
Buyers couldn’t push price past this level. And sellers couldn’t push price down.
There was no reason to keep buying NZD. And there was no new driver to instigate selling NZD.
For three months, price traded within a tight 300 pip range.
Fundamental analysis revealed the following:
New Zealand’s economy was struggling and economic data was still disappointing.
This started in Q4 2017, and continued into Q1 2018.
Economic outlook was dire. And analysts consensus was for the slow down to continue in 2018.
This is dovish. And could mean an interest rate cut. Rate cuts generally weaken a currency.
On the other hand, the United States’ economy was growing.
The Fed were increasing interest rates. And the USD was strengthening.
These fundamentals gave a high probability NZDUSD short trade.
And the technicals provided a strong resistance level to sell from.
You could have sold NZDUSD by trading into the next NZD news event. This was New Zealand’s quarterly GDP data on 14th March 2018.
Or waited to trade out of the news.
Both opportunities could have seen you pocket 800+ pips!
In this article, we’ve explained what support and resistance levels mean.
We’ve discussed the common ones and explained how they can benefit your trading.
We also demonstrated how to use them with fundamental analysis.
Combining them in this way can enhance your trading results.
It’s important to mention that support and resistance are not exact levels. So, it’s best to view them as zones.
Furthermore, the more tools that converge in the same place, more significant the area is.
Lastly, support and resistance are not limited to forex. They can be used for all market assets that have a graphical chart representation of price.
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We value all feedback and will use them to create new articles and content in the future.