Support and resistance are price levels that provide reference points on a price chart. Traders usually buy or sell from support and resistance levels.
In this article, we will discuss the following points:
- Explore support and resistance
- How to calculate support and resistance levels
- Concept popularity
- Stop loss and take profit placements
Exploring Support And Resistance
The concepts of support and resistance stem from technical analysis.
You should think of them as psychological price floors and ceilings, which you can mark on price charts.
Traders use these levels to determine the best entry points. They also help identify the best levels to place stop loss and take profit orders.
Let’s look at support levels first. These are levels at which a currency pair’s price doesn’t tend to fall below over a given time frame. When the price falls to this level, the market usually offers support, reversing the fall in price.
Resistance levels are the opposite. These are levels at which a currency pair’s price doesn’t tend to go above over a given time frame. Market resistance usually kicks in at this level, causing the price to reverse and fall.
How To Calculate Support And Resistance Levels
There are various ways to calculate support and resistance levels. Many traders use price chart tools to calculate key levels of support and resistance.
The most popular method involves basic price chart analysis. This allows traders to visualise price floors (support levels) and ceilings (resistance levels).
These are simply the highest and lowest price over a given time frame. The chart below demonstrates this process.
Some traders use Fibonacci retracements. Traders generate these by measuring previous movements in price. The Fibonacci tool then displays levels which traders then use as reference points.
Other common tools include pivot points, psychological price levels and moving average indicators.
Most technical indicators aren’t used by professional traders. However, both retail and professional traders use support levels.
Lots of traders use support and resistance levels. Because of this, they tend to be self-fulfilling in nature.
Traders use support and resistance levels as entry points for their trades.
For example, let’s say we want to buy the GBPUSD pair. Some traders will wait for its price to fall back to a support level before opening a long position.
Doing this means that traders can avoid opening positions at extreme highs or lows. This, in turn, minimises drawdown and market exposure.
Stop Loss And Take Profit Placements
These levels are also used to guide the placement of stop loss or take profit order.
By placing a stop loss just above a key resistance level (sell trades), or just under key resistance levels (buy trades), you can minimise your losses should the market move against you.
However, it’s vital that you don’t place your stop loss too close to these levels. The chart below explains why:
You can also maximise your profits by using support and resistance levels to place take profit orders.
Imagine if your buy trade was in profit and rising steadily. However, you can see it’s approaching a key level of resistance.
You know that the price will likely reverse once it hits this level, reducing your profits. In order to maximise your profits, you could place a take profit order just under the resistance level.
The same approach works when a sell trade is approaching a support level (please see chart below).
So what are Support and resistance?
Support and resistance levels are very common in the world of trading. It is a technical skill that will improve your trading results.
Studying and learning the art of support and resistance is very important in your overall development as a trader. It will help you find good entry points while identifying areas to place stop loss and take profits orders.
We wish you all the best with applying this skill to your trading.
If you have any questions or comments, feel free to let us know in the comment box below.