Learning how to identify support and resistance levels in forex is crucial in analyzing the market structure and structuring trades. Support and Resistance levels are critical points in any markets that shows where big buying and selling has been taking place in the past. Simply said, Support and Resistance levels provides a point of reference on the price chart which technical analysts watch out for as prices starts trading near these levels.
As we can see from the EURUSD Weekly timeframe chart shown above. The Resistance Line has seen multiple bounces downwards each time prices trades toward it and the Support Line has seen multiple bounces upwards when prices traded towards it.
Why does this happen?
For the Forex markets, it is the biggest traded market in the world and when support and resistance levels is holding it could be a myriad of factors
- Central Bank Intervention – A country’s monetary policy partly determines the supply and demand of the currency float. Central banks statements and actions have an effect in the country’s currency
- Interbank Market – The forex interbank market is the wholesale currency arena, where traders from large banking institutions trade amongst one another. Other participants such as hedge funds or trading firms that decide to participate in large transactions, are also part of the interbank market.
When prices reach a specific level, an interbank dealer can use their order book to determine if the market will be supported at that level or slice through it generating accelerating momentum. Many times, interbank dealers will use support and resistance lines or moving averages to assist in determining if there is technical confluence in tandem with their market depth order book.
Significance of a break in support and resistance levels
When Resistance level breaks, It signals that the market is ready to move higher with the resistance level now acting as an indication for new support. The previous resistance plays a psychological factor for market players and it acts as a key level to watch. Traders and investors tend to gravitate to these psychological price levels for several reasons. One is that these prices have been significant in the past and traders know they are likely to be again. Market participants often gauge future expectations based on what has happened in the past; if a support level worked in the past, the trader may assume that it will provide solid support again. The chart above shows clearly how previous resistance became support.
Support and Resistance levels are significant levels in the market. Due to how prices had reacted in the paste when prices were approaching these levels. it is often used by traders to structure their strategies and plans to trade the market. Knowing how to identify these levels provides us with a map to guide us on what direction to trade. For example if a significant key resistance level had been broken, we can look for buying opportunities to trade as it’s a strong indication that the market is ready to trade higher.