How to Trade Support and Resistance Breakout Strategy - TheForex7

Support and Resistance

What Are Support and Resistance?

Support and resistance form the basis of all technical chart formations.

Support represents an area where there is more enthusiasm for demand, which is sufficient to stop a decline at least temporarily.

Resistance represents an area where there is more enthusiasm for supply, which is sufficient to stop an advance at least temporarily.

It is important to note that supply and demand are always equal. When an amount of currency is sold, that same amount will be bought, and vice versa. When there is more enthusiasm for demand, it means that buyers are much more bullish than sellers are bearish, and so are more willing to buy at higher prices. This aggressive bidding action will then fulfill a price level as support. On the other hand, when there is more enthusiasm for selling, it means that sellers are much more bearish than buyers are bullish, and so are more willing to sell at lower prices.

It helps to visualize support as a floor and resistance as a ceiling.

Why Are They Important?

Previous support, when broken, becomes future resistance.

Previous resistance, when broken, becomes future support.

Once a support area has been violated on the way down, it later becomes resistance on the way up. The textbook reason behind this is that people who have bought at the support level earlier on saw their positions going against them when the prices went down, and now that the price has gone up again to the point where they bought, they took this opportunity to sell and close their positions. The selling pressure at this point is what makes the previous support a resistance now.

The same goes for resistance. Once a resistance area has been violated on the way up, it later becomes support on the way down.

However, in the real world of trading, theories of support and resistance work as a result of a self-fulfilling prophecy since so many Forex traders know that these levels will be noted by many other players.

How to Use Support and Resistance in Forex Charts?

As entry points:

- Buy near support level on bullish market sentiment

- Short near resistance level on bearish market sentiment

- Trade (short) the breakout from the support level if the market sentiment is bearish, but not necessarily short from this price support level ( take note of moving averages, Fibonacci levels, etc).

- Trade (long) the breakout from the resistance level if the market sentiment is bullish, but not necessarily long from this price resistance level ( take note of moving averages, Fibonacci levels, etc).

As exit points:

- Place your objective for a short position near a support level

- Place your objective for a long position near a resistance level

When a currency pair is consolidating, and you don't expect any significant news to sway its direction, it can be very profitable to buy bounces off support and to short sell at resistance and are low-risk ways to base your trades on. It helps to think of support and resistance as price areas, rather than specific price points since they may range from a few pips to more than 10 pips sometimes.

Real Chart Example

Figure 1

Figure 1 above shows a daily chart of NZD/USD with bold lines indicating support or resistance levels. The letter R marks resistance; Smarks support; F (circled blue) marks false breakouts on the chart. R -> Smarks previous resistance turned into support, whereas S -> R marks previous support turned into resistance. As you can see, support and resistance levels often switch their roles once they are penetrated.

Where They Can Be Found in Forex Charts

There are some guidelines for identifying potential support or resistance zones on currency charts:

• Round numbers of prices. Prices ending with '00' as the last 2 digits are strong psychological zones, for example, 1.2400. or 118.00. For prices that end with '000' as the last 3 digits, they are even stronger psychological zones than those with just 2 zeros as the last digits, for example, 1.1000, 1.2000, 1.3000. Prices will often move a bit beyond or fail to reach the actual numbers, so it is better to see them as zones rather than specific points. Mid-price levels are of particular significance, for example, 1.2500 for EUR/USD and USD/CHF, because it is where the crossover of their prices occurs.
• Previous daily highs or lows have a good tendency to become support or resistance zones. Intraday highs or lows are not as accurate as daily ones.
• Trendlines and moving averages are in fact dynamic support and resistance levels. In the case of an uptrend, it makes logical sense to place a buy order when the price declines to the trendline area. It is considered a low-risk trade if other chart indicators and market sentiment agree with the uptrend because you can place your stop below the line. Your stop will be hit if this support area becomes violated.
• Retracement levels as indicated by Fibonacci may serve as future support or resistance.

Significance of Support and Resistance

How can you determine how strong support or resistance can be? Here are several guidelines:

• The more times a zone has been able to stop and reverse a price trend, the more significant that zone becomes as a support or resistance. If a currency price has bounced off the support zone a few times, people will become accustomed to that zone as a support, and hence there will be more buying pressure to rally the price. A support or resistance zone in a daily or weekly chart will be much more significant than one that is on an hourly or less chart, because the longer the zone has been established as such, the more obvious it becomes to people. In the case of a support level, since most buyers would place their stops below it, and when this support becomes violated, the momentum for a downtrend becomes very strong as more stops below it are being triggered.
• The faster the price moves towards the support or resistance zone, the more significant that zone will be. If prices have been falling sharply towards a support area as compared to moving downward steadily, the more significant the support area becomes.
• The longer the time that has elapsed since the last time the zone acted as a support or resistance, the less significance it is likely to have. A support that was established a decade ago would be less significant than one that was formed 6 months ago.

Trading Tips

• It is not wise to buy at support if you see that a downtrend is very strong, especially one that is driven by strong market sentiment and bias. In any case, always have a tight stop below the support level.
• However, if the support level is a very major one, there is a chance that the downtrend might rebound - but maybe only for a short while. The same goes for short at resistance.