Supports and resistors are probably the most popular, well-known and widely used graphical analysis tools. No trader, even the most “purist” does without support and resistance.
However, many novice traders abuse or incompletely use support and resistance, so we’ll go into details on how to use them here.
Basic definitions of supports and resistances in graph analysis
A support is a price level (represented by a horizontal line on the charts) on which prices tend to stumble on the downside. That is to say that in a decline, if prices meet support, they will tend to stop their decline and bounce upwards. If prices cross this support, they are said to “break” it, which is a sign of an acceleration of the decline.
Conversely, a resistance is a price level on which prices tend to stumble upwards. That is to say that in a rise, if prices meet resistance, they will tend to stop their rise and start falling again. If prices break out of this resistance, we can expect an acceleration of the upside.
The link with Dow’s theory
As we specified in the previous lesson, all the principles and techniques of chart analysis are more or less based on Dow’s theory.
We had the opportunity to introduce the concept of “highs” (peaks) and “lows” (lows), and it is thanks to this concept that we can identify supports and resistances:
→ A support is therefore a horizontal line that passes through several troughs of the same level.
→ A resistance is therefore a horizontal line that crosses several peaks of the same level.
To draw on supports and resistances, you just have to:
1 / Identify the most significant peaks and troughs
2 / Identify peaks and troughs of the same level
You will then notice that supports and resistances are only “special cases” of the highest / lowest rule: instead of being increasing (rising) or decreasing (falling), they are of the same level.
Supports and resistances in practice
There are two main uses for supports and resistances: they can be used to set goals or as a trading decision tool.
Use Supports and Resistances to define your goals.
If you spot a sell signal and can also spot support, it might be worth placing a target just before support, as prices will tend to rise again after making contact with support.
Conversely, if you spot a buying opportunity and even a resistance, it might be wise to place a target just before the resistance as prices will tend to stop their rise in the resistance zone.
Use supports and resistances to trade.
Since prices have a particular behavior when approaching a support or resistance, it is possible to use this behavior to trade.
The case of the normal behavior of supports and resistances: buying on support and selling on resistance
We can therefore take a position to buy as support approaches, as we know that prices have a good chance of rising after hitting support.
Conversely, we can place a sell order if prices are approaching resistance, as they will tend a priori to start falling again after touching the resistance.
The case of support and resistance breakouts
Supports and resistances are not eternal, and therefore there comes a time when they break, which can give rise to trading opportunities as well.
Indeed, when a currency crosses resistance, a violent movement often occurs, as if the prices “release the pressure” built up by being held back by the resistance. It may therefore be appropriate to take a long position on a resistance cross.
The reverse also applies to supports, the break of which can provide sales opportunities.
The limits and difficulties in the practice of supports and resistances
In reality, the theoretical principles of supports and resistances are unfortunately sometimes difficult to apply … Supports and resistances are in fact rarely precise levels, but more “zones”.
It can therefore be difficult to identify the real breakouts and crossings if you lack experience, especially since the routes regularly “test” the supports and resistances and then immediately respect them again …
There are several techniques to confirm or invalidate these breaks and crossings, which for the most part are simply common sense. To learn more, we recommend that you know our The University of Forex video program, which includes very interesting details, as well as concrete examples on the practical implementation of supports and resistances.
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