Support and Resistance Levels are Keys to Unlocking Doors to Profits

Technical analysis embraces a wide spectrum of specialized “tools” that a forex trader must have within his personal toolbox if he has any hope for long-term consistency and success.  First, there are families of indicators, both leading and lagging, to become familiar with, followed by pattern recognition, another way to forecast the group psychology of other traders in the market.  Lastly, the complex art of analyzing and classifying waves of a trend adds another level of complexity to the landscape, but it also offers up the concept of Fibonacci Numbers to foreshadow retracement levels related to support and resistance.  Knowing these special zones can be all a trader needs to make profitable entries and exits in the market.

The underpinnings of technical analysis have always been three general principles: price represents the balance between supply and demand forces, specific patterns often repeat, and price behavior often occurs in trends that resemble wavelike patterns.  All three principles have laid the groundwork for centuries of analysis and study to arrive at the modern day tools that grace our desktops and guide us with the click of a mouse.  Many traders focus on predicting where resistance and support levels will predominantly occur, and then establish an entry/exit strategy to take advantage of what the “fibs” tell them to do.

A simple picture is worth a thousand words:

The letters “S, R, and PP” stand for the following terms:

  • Support:  A price level where buying pressure begins to exceed selling pressure, thereby forming a point or “floor” beneath which prices will not decline;
  • Resistance:  A price level where selling pressure begins to exceed buying pressure, thereby establishing a “roof” that blocks future price movements in the upward direction.
  • Pivot Point:  A level within which the sentiment of the market visibly changes from “bull” to “bear” or the reverse, typically used to forecast the future direction of the market.

The various lines in red, blue and black depict the situations defined above for various points on the trend line of candlestick formations displayed in the diagram.  Believe it or not, there are software programs that can take previous pricing behavior and predict where these levels will occur with a high degree of probability.

Many forex traders rely on various wave theories that project these levels at varying points on a pricing chart of a currency pair.  Proponents of Elliott Wave Theory use proportional retracement ratios to determine consistent projections for both resistance and support.  Many forex brokers will include these software tools in their respective trading platforms to support online forex trading.

Wave theory has also developed ingenious ways to use what are called Fibonacci Numbers.  These numbers and their ratios appear in nature and have been referred to as the golden ratio or the golden spiral.  Fibonacci numbers have been found to be useful in financial/currency markets to develop trading algorithms, applications and strategies.  Forex traders use Fibonacci support and resistance lines, or “Fibs”, as an analytical way to determine the best entry and exit points for a trade or the placement of stop losses.

Forex traders anticipate “retracements”, those levels where the price of a currency will predictably move with some consistency.  If a currency price moves “A” in one direction, and then returns moving only “B” in the opposite direction, the “B” movement is the retracement.  The ratio of “A/B” typically approximates one of the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%.

Invest your time learning to use these software tools for more effective trading results.

About The Author

Carlos

Founder ForesightFX.com