The concept of supports and resistances is the base of technical analysis. When certain price levels are reached, the currency pair will experience fluctuations, resulting in a possible trend reversal.

When prices are falling, they will encounter supports. Buying interests are concentrated around these values, which can put an end to the decline. During a rise, prices encounter resistances. That is where selling interests are positioned, which may put an end to the appreciation.

TA uses various methods to identify supports and resistances. Among the most popular ones are prior bottoms and tops, trend lines, moving averages, Fibonacci retracements and pivot points.

Horizontal S/R. Chart 1: MetaTrader4

Chart 1: Horizontal Support and Resistance. Chart: MetaTrader4

The chart shows how the downward trend reaches a support zone. The few attempts to continue the decline were unsuccessful, after which the bulls took control. The subsequent rise has in turn reached resistance levels which have been repeatedly tested, but the sellers have held position.

This example presents horizontally located support and resistance. The more times they are unsuccessfully tested, the stronger they are considered and the more significant their role will be in the future.

Horizontal Resistance Line. Chart 2: MetaTrader4

Chart 2: Horizontal Resistance Line. Chart: MetaTrader4

At the beginning of Chart 2, we can see how the sellers have held their positions, which fixed resistance levels. It is also evident how the resistance has limited upward movements forward in time (second half of the chart).

This is largely the result of the collective psyche of technical analysts. When support or resistance is identified, many traders place their orders around these levels. In this case, selling interests are concentrated around the resistance. Some traders look for opportunities to open short positions with a stop above the resistance zone (the horizontal line). Others, having profited from the rise, prefer to take what they have earned. In both cases, it is sell orders that push the price down.

However, the resistance has been broken at the end of the chart. This moment represents a breakout and is key. Many sellers’ stop orders have probably been hit, which puts the bulls in a dominant position. Once the breakout has occurred, the horizontal resistance reverses its role and becomes support. The same would be true when a support is broken – it becomes a future resistance.

Breakouts in technical analysis should be considered with caution as there are often false ones. Traders usually want to see additional arguments that the respective resistance or support has been overcome. Many expect a closing price for the day above/below the respective resistance/support. Increased volumes would signal increased trading activity, validating the breakout.

The supports and resistances described in the above examples are static – they are located at specific levels. Traders often try to find dynamic support and resistance within the trend. Moving averages are a common approach to achieving this goal.

Moving Average Support/Resistance. Chart 3: MetaTrader4

Chart 3: Moving Average Support and Resistance. Chart: MetaTrader4

During the upward trend in Chart 3, the declines have met support around the moving average. When the trend has turned downwards, the average has started to play the role of resistance.

Of course, the choice of MA settings is individual. Accordingly, two different averages will give different results in an otherwise identical situation. Most traders will not rely entirely on the average to manage their positions, but the example demonstrates the idea of dynamic S/R.

Dynamic supports and resistances give the best results when there is a clear trend. Trend lines are one of the most commonly used methods for identifying supports and resistances

Trendline Support/Resistance. Chart 4: MetaTrader4

Chart 4: Trendline Support and Resistance. Chart: MetaTrader4

The upward trend from the first half of Chart 4 has found support when reaching the rising trend line. The formation of the top is also interesting. Several attempts to continue the rise have failed. Probably at this point, other technical tools have signalled an increased likelihood of a reversal. Gradually, the bears have taken control. During the decline, the downward trend line acted as a key resistance.

Trend lines are one of the most commonly used position management tools. They provide relatively intuitive levels around which to open a position or move a stop order.

Another commonly used method for determining supports and resistances is Fibonacci retracement levels. They are static levels defined as a percentage correction of a trend.

Fibonacci Support/Resistance. Chart 5: MetaTrader4

Chart 5: Fibonacci Support and Resistance. Chart: MetaTrader4

Chart 5 shows how the sharp rise has formed a top and a corrective move has started. Around the 50% retracement levels, however, the currency pair has encountered support. The reversal pattern of candles formed has signaled a possible resumption of the appreciation. Apparently, selling interest was strong around the previous high, resulting in a new decline. It has capped around another important Fibonacci level – the 38.2% retracement. The pair has been consolidating there for some time – the balance of sellers and buyers has been evened out. The subsequent rise and the break of the two highs have confirmed the recovery of the upward trend. Fibonacci retracements of 38.2%, 50% and 62.8% are considered the most significant.

The methods described above represent just a few options to define key price levels. The round numbers, for example, follow an alternative logic without direct dependence on the chart. The idea is that large investors position their orders around round values (e.g., EUR/USD 1.1000, 1.1100, 1.1200, etc.), making these levels more significant.

Pivot points are another way to determine important levels. They mathematically manipulate price data for previous periods and project potential key values into the future.

In exchange-traded financial instruments (such as stocks), many traders look at the levels where high trading volumes are generated.

By gaining experience, each trader finds the appropriate to his strategy approach of identifying support and resistance levels. These are of utmost importance to technical analysts who place their orders around these values.

Next: Trend Lines

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