One of the most commonly known tradable edges that occurs in financial markets today is that of support and resistance. However, despite being widely known about, how to actually profit from support and resistance is far less well understood. In this article I am going to write about tradable edges in the Forex market, why support and resistance occurs, how to identify support and resistance on price charts when it does occur, and, most importantly, how to profit from it.
“One of the most commonly known tradable edges that occurs in financial markets today is that of support and resistance!“
Tradable edges in the Forex market
Believe it or not, the biggest edge in the Forex market does not come from support and resistance. The biggest edge for Foreign Exchange traders is the trend. In Forex, you cannot (usually) trade support and resistance directly, in FX trading you have to trade in the direction of the long-term underlying trend. However support and resistance can still be very useful for timing ones entries, but first, I would like to discuss why support and resistance occurs in the first place.
Why support & resistance occurs
Support and resistance occurs because of the actions of speculators, they see recent highs or lows on a chart and place their buys on stops there – this also explains the phenomenon where the market often seems to be attracted to ‘round’ numbers as prices often reach round numbers only to find support or meet resistance at these levels.
How to identify support & resistance on price charts,
On price charts, support and resistance is very easy to spot, and in theory, any two high or low points on a price chart can have a line drawn between them and be used as a support or resistance level. It is however very easy to link two arbitrary points on a candle stick price chart and draw a line between them only to find that the resulting line does not hold and has no real value and I would therefore caution the reader by noting the following observations that I have made.
1. Support and resistance levels should be very easy to spot –
they should immediately jump out at you. Support and resistance levels need to be immediately obvious as it is only if they are so that they actually stand a chance of working. If these price levels are immediately obviously to you then the chances are that they are also immediately obvious to tens of thousands of other traders too and will therefore attract the levels of capital from enough other market participants required to actually make them work. Remember, there is no other reason why support and resistance levels should work other than they are obvious thousands of traders and capitals flows are therefore supporting a price or resisting further price movement at these levels.
2. Support and resistance works best on larger time frames.
This point needs very little explanation, trends and other edges are generally strongest when they occur on larger time frames.
3. The more times the price bounces off of a support or resistance line, the more likely it is to hold (although all support and resistance lines will eventually break).
4. The flatter the support and resistance lines are, the more likely they are to hold. An example of what I mean by this is below image…
How to profit from support & resistance
In the Forex market the trend is still the trader’s best friend and it is very unwise to bet against it. However, support and resistance can still be used to time an entry. If I were seeking to profit from support and resistance in the Foreign Exchange market I would look at the direction of the long-term trend and seek to enter at an area of strong support during an uptrend or an area of strong resistance during a down trend. In effect I would be using the trend to determine the direction of my trade and support and resistance to determine the price I would buying or selling at.
Read more about support and resistance on Wikipedia.org
You also might be interested in reading our forex glossary to understand basic forex terms.