Forex 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…

Forex Trading Strategies #4 – Support and Resistance

I will take a minute and define what supports and resistances are for those of you who 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/resistance:

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

Support or resistances are areas where 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?  Technically, support on a candlestick chart is when you have a low-middle candle with two higher candles to the left and two higher candles to the right. 

We usually only worry about support when the market is trending down, 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 two lower candles to the left and two lower candles to the right… And, of course, we only worry about resistance when the market is trending up because we want to pay attention to the possibility of reversals or “bounces” backs.

You may ask about timeframes, such as the timeframe we use for these support/resistance levels.  I 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 to 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 four strategies into consideration:

1. Real Reason – AUDUSD pair – Why? RBA Interest Rate Decision
2. Right Timing – During the RBA Meeting, scheduled time to take advantage of market volatility and possibly see the market trends 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 risky currency, and it has been overvalued for too long… Also, considering 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 bouncebacks… 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 the 1.0450 level since we may not see much momentum going upward…

As the market drops on weaker AUD, you can get out at the 1.0355 ~ 1.0340 area, which 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:

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

Most people will choose a Taxi as it is the most logical choice, and of course, that’s the right answer! The Forex market is driven by supply and demand… market moves up when there are more buyers than sellers, and the 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 often, I see traders “predicting” where the market is going and failing miserably or picking a past chart and trying 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…

Supply and Demand

In case you missed it, let me repeat: the market goes up when there are more buyers than sellers and 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 more people were 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 selling, driving 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, or mathematical methods people are using, they all seem to converge at the support/resistance levels, so much so that it was able to turn the tides of the market and created reversals…

Considering 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 a similar reaction in the market?  I believe so, and I have seen them working repeatedly…

In conclusion, support/resistance levels are fundamental to technical trading.  They represent actual levels where real traders with real money drove the market, and it is logical to expect the same reaction when the market retests these levels again.   (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,