Forex Trading Strategies #4 – Support and Resistance

This is the 4th article on my 7-part series of Forex Trading Strategies, Click here to read Part-3: The Correct Trend…

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Forex Trading Strategies #4 – Support and Resistance

I’m going to take a minute and define what are supports and resistances for those of you that aren’t familiar with the term, you may skip down to the next section if you already know what they are, and as usual, prepare to be surprised at the end because I’ll prove to you how effective this simple strategy is, and the reasons why…

Here’s what Wikipedia has to say about support/resistances:

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A support level is a price level where the price tends to find support as it is going down. This means the price is more likely to “bounce” off this level rather than break through it. However, once the price has passed this level, by an amount exceeding some noise, it is likely to continue dropping until it finds another support level.

A resistance level is the opposite of a support level. It is where the price tends to find resistance as it is going up. This means the price is more likely to “bounce” off this level rather than break through it. However, once the price has passed this level, by an amount exceeding some noise, it is likely that it will continue rising until it finds another resistance level.

SUPPORT

Basically a support or resistances are areas that the market is likely to “bounce” back… they are not called top/bottom because supports/resistances are meant to be broken, so don’t get married to a position thinking that a level is going to hold forever…

So how do we identify these levels?  Well, technically, a support on a candlestick chart is when you have a low middle candle with 2 higher candles to the left and 2 higher candles to the right. 

We usually only worry about support when the market is trending down, you know, paying attention only to potential reversals or “bounce” backs…

RESISTANCE

Resistance is exactly the opposite of Support, and on a candlestick chart, you are looking at a middle high candle with 2 lower candles to the left and 2 lower candles to the right… And of course, we only worry about resistances when the market is trending up, because we want to pay attention to the possibility of reversals or “bounce” backs.

You may ask about timeframes, such as which timeframe do we use for these support/resistance levels?  I personally start from the 1Hour chart and up to find the next level… so if the market is going up and I don’t see the next resistance on 1H, I’ll go to 4H, Daily, and even weekly for find possible reversal levels…

You can use these levels as your take profit targets, entry, or even stop loss… the key is to consider the trend and plan your entry…

Support & Resistance Combined Forex Trading Strategies Entry Consideration

Here’s how to put the first 4 strategies into consideration:

  1. Real Reason – AUDUSD pair – Why? RBA Interest Rate Decision
  2. Right Timing – During RBA Meeting scheduled time to take advantage of market volatility and possibly see market trend for the rest of the trading day…
  3. Correct Trend – Recent CPI q/q release puts RBA at a disadvantage, plus the global economic slowdown should add to the risk aversion sentiment… at the end of the day, AUD is a risk currency and it has been overvalued for too long… Also consider RBA might institute a series of rate cuts starting in May 2012, the outlook for AUD is bearish…
  4. Support & Resistance – Since we are looking for a SELL, we should look for levels to SELL or when AUDUSD is trending up to resistance areas for bounce backs… Here is what I see:

I see possible entries to SELL AUDUSD from 1.0427, 1.0446, 1.0460, and 1.0472… With 1.0472 being the ideal entry and 1.0427 being the most realistic as it is the closest to the current price action… I’ll probably settle for anything above 1.0450 level, since we may not see much momentum going upwards…

As the market drops on weaker AUD, you can get out at 1.0355 ~ 1.0340 area, that is the first level of support and we may see a bounce back in the pair…

The Reason Why – Support & Resistance

Now that we’ve gotten the entries and how to identify support/resistances out of the way, let’s discuss briefly the logic or the reason why I use this strategy.

Let me try to put this in the simplest way possible… Here’s the question: Which mode of transportation has more similarity to Forex trading, Subway or Taxi? Now that’s an odd question to ask, I know, but here are some insights:

  • Subway runs on a fixed schedule and goes to fixed numbers of stations.
  • Taxis  go where fares demand… if there is a ball game at a nearby stadium, you will get more taxis there.

I guess most people will choose Taxi as it is the most logical choice, and of course, that’s the right answer! Forex market is driven by supply and demand… market moves up when there are more buyers than sellers, and market moves down when there are more sellers than buyers… Not because of some Elliot Wave theory, candlestick engulfing patterns, or fibonacci retracements or extensions… So many times I see traders “predicting” where the market is going and ended up failing miserably or pick a past chart and try to analyze with indicators and technical mumbo jumbo like pros… (hindsight is 20/20 for everyone) but if they only paid attention to the obvious…

Just in case you missed it, let me repeat it again, market goes up when there are more buyers than sellers, and goes down when there are more sellers than buyers…

It is simple really, and when you refer to the chart above, you see AUDUSD moved up from 1.0355 to 1.04720 initially, it meant that there were more people buying, people who use real money to place these trades and drove the market up… not some chartists sitting in his office and predicting that the market is going up… Then once it reached 1.04720, people with real money decided to sell off their AUDUSD holdings, so much so that there are now more people with real money selling and drove the market down to the 1.0410 level.

In essence, if you pay attention to these support/resistance levels, you are going to be ahead of the game because no matter what technical, psychological, mathematical methods people are using, they all seemed to converge at the support/resistance levels, so much so that it was able to turn the tides of the market and created reversals… If you consider the volume it takes to change market direction, you’d understand how impressive that is…

So when the market tests these levels again, isn’t it possible that the same reasons (regardless of whatever, they are irrelevant) would call for similar reaction in the market?  I believe so, and I have seen them working time and time again…

In conclusion, I believe Support/Resistance levels are the fundamental of technical trading.  They represent actual levels where real traders with real money drove the market, and it is just logical to expect the same reaction when market retests these levels again.   (Simply put, these levels transcend above technical, psychological, fundamental, order flows, etc… they are the convergence of all of the above, a force to reckon with, a fact that demands respect).

So mark these levels on your chart and start trading profitably today,

About Henry Liu

My name is Henry Liu and I am a Forex Trader and Mentor. I help traders achieve consistent income trading Forex while spending less time trading. My focus in trading is a combination of Fundamental Analysis, Technical Analysis, and Market Sentiment. Far too many retail Forex traders concentrate on just one aspect of trading, technical analysis, and ignore everything else; it is my goal (and vision) to educate every trader on how to take advantage of news trading and become more balanced traders.

You can find more information about me on my Google Profile.

Comments

  1. You are doing a good work. Some people could have charged $40 above for this pieces of educative information. Thank u. Well done, more power to your elbow looking forward to be your student one day. Is there any means to identify support and resistance in case i didn’t see two lower or high candle on my chart?

    • you can also look at congestion areas if you don’t find support/resistance… but always look for at least 2 candles lower/higher on both sides.

  2. lanre oladimeji says:

    Excellent! succinct, concise and direct. Very insightful and packed with wisdom. Many thanks Henry, you have finally demystified the logic behind the supp/res. strategy. Many many thanks for your generous attitude to make others winners like you… God bless you magnanimously.

  3. Richard Ong says:

    Henry

    An excellent article that epitomise the very core of forex trading. No fancy indicators etc just plain price action of support and resistance.

  4. peter cham says:

    Thank you so much mr.Henry,I got the ideas support and resistance now from the above learning. Thank you once again for your unselfish sharing. Hoping to learn more from you again.

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