Support and resistance are the two basic elements of Forex technical analysis and are often found complicated in understanding especially for beginners. They are used to read charts and provide information about the market. Support and resistance levels determine three important points in every chart analysis:
These three points can be discovered by identifying the levels of support and resistance on a chart. A trader is successful only when he is efficiently able to answer these three questions.
Support is a price level which tends to stop price from falling below a specific point. Hence a currency pair has difficulty going below the support level. Resistance is the price level which acts as price ceiling and a currency pair cannot break above this level. These two levels make up the price floor and ceiling and a pair can move only between these levels.
The ongoing battle of technical analysts between bulls and bears or buyers and sellers can be explained through support and resistance levels. In this context, support will be the price level which gives you enough buying power (demand) to prevent the price from going down any further. This happens because as price gets closer to the floor (support level), the cheaper deals will attract buyers who are more likely to buy now. On the other hand, these cheaper deals prove less beneficial for the sellers who will sell less. Hence, the demand will overcome supply and price will not be able to fall below support.
Sometimes it happens that sellers (bears) win over the buyers (bulls) and the support level breaks down. Now trading behavior is more inclined towards selling than buying. In such cases, as one support is breached, another level of support is established at buyers’ next point of stand.
Similarly, the resistance level will be the one at which selling power (supply) is enough to prevent the price from increasing any further. This happens because when price gets closer to resistance, more expensive deals push the sellers to sell whereas buyers will be less likely to buy at high prices. Now supply has overcome demand which restricts the price from rising above resistance level.
Just like support, there come points when buyers (bulls) win over the sellers (bears) and that is when resistance is broken. Since price is continuously rising, buyers will now be willing to buy at those higher prices. When one resistance level is broken, another resistance is formed at the next level where sellers establish themselves.
Determining the support and resistance levels makes it easier to decide when to open or close trades. Generally, when a chart has longer time frame, the support and resistance levels will also be stronger. Which means the strength of support and resistance will be low in a 1-hour chart as compared to a daily chart.
You can see how important and beneficial these two elements are. Determining future levels of support and resistance can help create accurate picture of the trade.