Support and Resistance

Support and resistance is one of the most widely used concepts in trading.

Support is created at points below current price where there are enough buyers to stop - and eventually reverse - the fall in the price of the currency pair.

Resistance is created at points above the current price where there are enough sellers to stop - and eventually reverse - the increase in the price of the currency pair.

Here is a basic representation of support and resistance.

Support Support gives the market a 'floor'. When price drops to the support level, price usually (but not always) rebounds.

Prices usually rebound at support because this is where buyers tend to jump in. More buyers mean increased demand for the currency pair. Increased demand leads to higher prices. When the price falls to a strong support level, traders should expect buyers to step in and drive the price up, or at least keep it from moving any lower.

Here is an illustration of strong support leading to rising prices.

Resistance Resistance performs the opposite function of support. Resistance provides a 'ceiling' to the market.

When the price rises to a strong resistance level, prices tend to rebound downward as sellers enter the market. More sellers lead to greater supply. Greater supply leads to falling prices. Traders in long positions (those who bought earlier) may cover their positions (they sell to exit their trades). This combination of selling pressure often drives the price lower still.

Here is an illustration of strong resistance leading to falling prices.

Psychological Resistance and Support There is a tendency for round numbers to provide significant support and resistance. Prices that end in 00 tend to provide stronger support and resistance. Prices ending in 50 provide secondary support and resistance.

These round numbers, therefore, are often referred to as "psychological" support or resistance levels.

In the chart below note how the market respected the 1.4700 and 1.4800 EUR/USD level, and to a lesser extent the 1.4750 level.

The tendency for markets to respect round numbers is one of those peculiar market characteristics that can prove most useful in technical trading.

When resistance is broken Because resistance levels are prices where sellers are supposed to be strong, if the price breaks through resistance, traders tend to take note. It shows there is more buying pressure (or less selling pressure) than previously thought. This often leads more traders to close their short positions by buying, sending prices higher still.

When price breaks through resistance, it often triggers a large number of stop orders. Stop orders are placed by traders to limit their losses if prices move against them. The stop orders triggered are those of the sellers who entered the market at resistance, expecting the price to rebound. A seller's stop order is really an order to buy (at a specified price) when price moves against him.

The stop orders triggered create even greater buying power (demand) leading to further price rises. Often the stronger the resistant level, the greater the number of stops that are triggered and the larger the move above resistance.

Here's an illustration of what happens when resistance is broken.

When support is broken The opposite occurs when support is broken.

Because support levels are prices where buyers are supposed to be strong, if the price falls below support, traders tend to take note. It shows there is more selling pressure (or less buying pressure) than previously thought. This often leads more traders to close their long positions by selling, sending prices lower still.

When price breaks through support, it often triggers a large number of stop orders. The stop orders triggered are those of the buyers who entered the market at support, expecting the price to rebound upwards. A buyer's stop order is really an order to sell (at a specified price) when price moves against him.

The stop orders triggered create even greater selling power (supply). Often the stronger the support level, the greater the number of stops that are triggered and the larger the move below support.

Moves above resistance or below support are called breakouts.

Here is an illustration of what happens when support is broken.



False Breakouts Not every breakout is valid.

Because it is known that many traders place stops just above resistance, some large institutional traders attempt to drive the price higher in the short term just to trigger these stops. This is called stop hunting. Without any real force behind the move higher, the price can fall back to resistance.

The same dangers of false breakouts apply to support levels.

Here is an example of a false breakout.

After Support is breached When prices break through support, that support then becomes resistance.

Here is an illustration of support becoming resistance.

The dotted line shows strong support at points 1 and 2. But this support turns into resistance (points 3 and 4) once the price falls below it.

Let's see how this might look on an actual graph.

After Resistance is breached When prices break through resistance, that resistance then becomes support.

Here is an illustration of resistance becoming support.

Points 1 and 2 are resistance levels But resistance turns into support (points 3 and 4) once price breaks through it. The more often price tests a level of resistance or support without breaking it, the stronger the area of resistance or support is. This is illustrated in the chart below.