In the Forex market, support and resistance lines are formed when the price repeatedly returns to a certain level before reversing. When the price goes down and then reverses back up after hitting this level, the line produced is called “support.” When the price goes up and then reverses after hitting this level, it is called “resistance.” Traders often use these lines as entry and exit points in trades.
Support and resistance example
Here is an example of support and resistance on a chart.
Looking at this chart, we can see that since late August/early September of 2018, the price of AUD/USD has been unable to break through a horizontal line at 0.72745. It first fell below this line in late August. It then moved slightly above it in mid-September before reversing. In early November, it once again tried to move above this line and failed. For this reason, we can say that 0.72745 is a line of resistance.
We can also see that the price has attempted twice to break down below 0.70412. The first attempt was in late September and early October. The second was in late October. In both cases, the price rallied after hitting this line. For this reason, we can say that 0.70412 is acting as a line of support.
Points to remember about support and resistance
First, it is important to recognize that support and resistance levels are not exact. The price may go slightly above resistance or slightly below support before reversing. If that happens, most traders will not consider the line to have been broken. So it could be argued that it is more accurate to speak of “areas” rather than “lines” of support and resistance.
Here are a few other points to remember when using lines of support and resistance:
- Support becomes resistance (and vice-versa). When a line of support is broken, it often becomes a line of resistance in the future. When a line of resistance is broken, it often becomes a line of support in the future
- The more often a line is hit without being broken, the stronger it usually is.
- When a line breaks, the strength of the follow-through is usually proportional to the strength of the line. For example, if a line of resistance has been hit six times and then breaks on the seventh try, we should expect to see a much stronger follow-through move up then if the resistance had only been hit twice before being broken
How to trade using support and resistance
There are several strategies traders can use to take advantage of support and resistance lines. Here are a few of them.
- Go long near support, exit near resistance. If a trader believes the current lines will hold, buying just above support and selling just below resistance can be an effective strategy
- Go short near resistance, exit near support. This is the opposite of the previous strategy. A trader can sell just before the price reaches resistance and then buy the currency back just before it falls to support. This can be a reasonable strategy if the trader believes current lines will hold
- Wait for a break, then follow the momentum. If a trader believes one of the current lines will not hold, he can buy just after resistance breaks or go short just after support breaks. If the line that is broken has been tested multiple times and not failed, the follow-through after it is broken may be very strong. This may lead to a profitable trade
- Place a stop just below support or just above resistance. If a trader is going long, placing a stop just below support may be an effective means of limiting losses in case support breaks. If a trader is going short, placing a stop just above resistance can achieve a similar aim
Recognizing lines of support and resistance is one of the most used tools of successful traders. It allows traders to recognize at what levels the price is likely to reverse, and to approximate how strong the resulting move will be if the price does not reverse at these levels.