The levels of support and resistance are a very important link in the construction of an analytical and trading system on Forex and logically follow from the structure of the trend movement.
From the point of view of decision making by traders, support and resistance levels are the price levels that a significant number of large traders regard as a point profitable in terms of buying or selling a currency. This unity of opinion among most traders leads to the fact that when prices approach resistance or support level, a significant number of market participants begin to sell or buy currencies with market orders, or by placing pending orders placed on the dealer’s behalf.
As a rule, pending orders are placed not at one price level, but in a certain price zone, forming not a clear level of support or resistance, but a support or resistance zone.
Placement of uniform orders in the same zones occurs because different traders, using similar rules of technical analysis, calculate approximately the same level of rates for sales and purchases, resulting in an inverse relationship between the methods of technical analysis and the nature of market movements.
Stronger are the levels held on the senior timeframe. Recall that support and resistance levels are not just lines on the chart, but rather zones in which traders make decisions, which is why they are important in technical analysis. We will put the levels (yellow lines) and the zones (blue zones) on the daily chart of EURUSD.
Look at the chart, the price for a long period of time – more than two years constantly interact with the same long-term levels. Reversal figures also tend to be placed near long-term levels, as detailed in the article “Reversal models in the forex market“.
When determining levels, it is important to observe the following simple rules: the price should interact as much as possible with the level in the past and the level should be clearly visible to all traders, regardless of the broker’s quotes, sight or tastes of the trading terminal.
Why levels are so important in technical analysis on Forex. Look at the right part of the chart of any currency pair from the current price. What do you see there? Nothing – emptiness. The future is not known to us and we do not know where the price will be after a certain period of time. All technical indicators work with past prices and only a few technical tools – channels, trend lines and levels are directed to the future.
Levels specify the ordered structure of probable future scenarios of developments in the forex market. They like chess cages or staircases share the field of trade and allow traders to have not only a temporary but also a price link in the future, allowing them to plan their trading decisions and, among other things, calculate their risks on the basis of the “if … .., then … . “. If the price breaks long-term level, then it is likely to go to the next level. If the price does not reach the level or breaks from it, then it is likely that it will return to the previous level. And so on. There are not so many options. The main thing in this analysis is that traders see goals at long-term levels and will try to reach them. And simple traders have to follow the big players.
What decisions are made by traders on the basis of levels. First of all, they serve for setting goals and setting the orders take profit. This is the main reason why the price is much more often beat off from the level than it breaks through. Behind levels, stop loss orders are set, limiting risks, and therefore levels are often protected by traders. Pending limit orders are set next to the levels, which allows traders to enter the market at the best price.
We examined the long-term levels, and how to deal with intraday trading. Short-term levels conducted through closest peaks or valleys to the current price are also used by traders to place pending orders, enter the market or close positions.
Let’s analyze how large traders (banks) place their pending orders within a day. This information is available on the Internet on specialized websites. For example, on February 26, the EURUSD pair had the following order grid.
Large orders are allocated in bold color. Put them on the hourly chart of the EURUSD currency pair.
Accordingly, the green lines are the buy orders (Bids), the pink lines – the sale orders (Offers). The analyzed period is highlighted by a blue brace with an arrow down. Information about orders is usually available for the opening of the European session. I specifically waited for the evening to show how the price interacts with the orders placed.
Orange hands I pointed to High and Low on the chart, which were accounted for by banks when placing orders.
We see that after the Asian session, the price met resistance from the warrant for number 2, overcoming its pair met sellers at order No. 1, which was placed at the last High. The buyers could not overcome it and the pair went down. The pair was met by buyers at order No. 3, which was exhibited at the last Low. A similar picture is present on all currency pairs within a day.
Thus, support-resistance levels do not arise simply because there was a peak or a trough in the price chart at these levels, but because large traders use these points on the charts to place their pending orders. Also, we must take into account that the issued orders do not exist there forever. During the trading day, for some reason or other, large traders can correct, reposition or remove them.
How to use support-resistance levels in trade.
There are only 3 possible variants of price interaction with the level – rebound, false breakdown and breakdown. Please note that two of the three options provide for the return of the price to the original trading range.
This means that when the price approaches the level, we expect a rebound or a false breakdown with a greater probability than a breakdown. And therefore it is undesirable to open Sell transactions near the support level and the Buy transaction near the resistance level.
On the chart of the Japanese yen (pairs USDJPY) the blue arrows indicate the bars that form the level, the number 1 – the rebound from the level, the figure 2 – the false breakdown of the level, the figure 3 – the breakdown of the level. Note how the broken resistance levels become support levels and vice versa. These are the so-called mirror levels.
When the price confidently breaks the level of support or resistance, as a rule, there is an acceleration of movement from the triggering of stop orders and entry into the market of traders trading at breakdown levels. In the event that the level was a large number of stops and the penetration level was active and unexpected for the majority of traders, this could lead to a situation of “short squeeze“.
The strongest and most reliable signal for entering the market when level penetration is level retest. This is due to the specifics of the trend price movement, which you can read about in the article “How to determine the trend and its reversal on Forex“.
A level retest occurs when the price clearly breaks through the level, and then returns to it. As if testing the pierced level. At the moment of price return to the level, traders who were in a loss-making position close their positions in lossless or with minimal losses, and traders who missed the level breakdown are included in the trend movement. Also, traders who previously entered the right direction can add to their positions on retest. All this leads to an acceleration of the price movement in the direction of breakdown after the test of the pierced support or resistance level.
The most difficult case arising from the interaction of the price of a currency pair with the levels of support or resistance are bullish and bear traps in the forex market. This is a fairly common phenomenon and traders need to be able to identify them and use them in their trading. They are described in detail in the article – “Bull and bear traps in the forex market.”
Levels of support and resistance are one of the main methods of technical analysis in the forex market. Understanding and using them in making trade decisions is in fact a ready-made simple and reliable trading system in the foreign exchange market.
Long-term levels for major forex currency pairs, US dollar index (USDX), Brent oil and gold (XAUUSD) are listed in the article “Long-term levels on the main currency pairs of the forex market“.
The logical development of the methodology of support and resistance levels on Forex is the theory of demand / supply zones. You can read about this in the article “Forex Trading from Supply and Demand Zones”.
If you have any questions regarding the definition and use of support and resistance levels, including the current situation in the forex market, – write in the comments or on the page “Contacts” of this site – we will understand together.
Be prudent, observe risk management and trade in a plus.