Determining the levels of support and resistance for a currency pair is one of the key concepts of modern forex technical analysis.
This type of chart analysis provides invaluable information for most short and medium-term trading strategies.
Support and Resistance Defined
Support consists of the levels on a price chart where the currency pair has met with an abundance of buy orders at a certain price level. This is often sufficient to stop and even reverse the market, usually after a period of declines.
The support comes from the fact that whenever that level of the exchange rate is achieved, the market usually rallies after unsuccessfully attempting to fall because it encounters considerable buy orders that support the price. Support levels tend to rise in a rising market and fall in a declining market.
Resistance, on the other hand, consists of a price level in a currency pair where no further buying interest can penetrate, partly because the price has reached an unsustainable level and the market has been saturated with sell orders. Resistance levels generally fall in a declining market and rise in a rising market.
Trading Off of Support and Resistance Levels
Once recognized, support levels can be traded by placing a bid just ahead of the support level, with a stop loss order just below the support level.
By then patiently waiting for the order level to trade, the trader will benefit from the advantageous rate achieved with rather low risk. If the trade is profitable, they can also move their stops to move favorable levels as the exchange rate improves. If not, then their position will be stopped out.
Resistance levels can also be beneficial to trade by using them to liquidate long positions. Also, shorting the market ahead of resistance levels with close buy stops placed above the resistance point is a popular short and medium term trading strategy.