The Role of Support and Resistance in Market Trends and Price Action
The concept of support and resistance is the basis of technical analysis. When certain price levels are reached, the currency pair may experience fluctuations, which can result in a trend reversal.
Support and Resistance Levels (S/R)
- Supports: When prices are falling, they will encounter support. Buying interests are concentrated around these levels, which can halt the decline.
- Resistances: During an uptrend, prices encounter resistances. That is where selling interests are positioned, which may end the appreciation.
Technical Analysis (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.
Static Supports / Resistances
Horizontal Support and Resistance
Chart 1: Horizontal Support and Resistance. Source: MetaTrader4
Horizontal Lines
Chart 1 shows how the downward continuation was rejected multiple times, establishing a horizontal support line. Bulls took control in this area, and the subsequent uptrend reached resistance levels that were repeatedly tested, but the sellers’ power was dominant.
The chart presents horizontally located support and resistance. The more times it is unsuccessfully tested, the stronger and more significant its role will be.
Chart 2: Horizontal Resistance Line. Source: MetaTrader4
The first part of Chart 2 shows where sellers dominated. As a result, a horizontal resistance line was established. This resistance played its role again forward in time (the second half of the chart).
Such situations represent the collective psyche of technical analysts. Many traders place their orders around these levels when support or resistance is identified. 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. Others, having profited from the rise, prefer to take what they have earned. In both cases, selling orders push the price down.
However, the resistance has been broken at the end of the chart. This moment represents a breakout and is critical. Once the breakout has occurred, the horizontal resistance reverses its role and becomes a support. The same would be true when broken support becomes future resistance.
Horizontal lines are among the most used position management tools. They provide relatively intuitive levels around which to open a position, place a stop-loss, or take a profit. Another commonly used method for determining horizontal supports and resistances is Fibonacci retracements. These static levels are defined as a percentage correction of a trend.
Fibonacci Support and Resistance
Chart 3: Fibonacci Support and Resistance. Source: MetaTrader4
Chart 3 shows how the sharp rise has formed a top, and a corrective move started. Around the 50% retracement level, the currency pair encountered support. The reversal candlestick pattern has signaled a possible resumption of the uptrend. Apparently, selling interest was strong around the previous high, resulting in a new decline. It has capped around the 38.2% retracement – critical Fibonacci level. The pair has been consolidating in that range for a while, as the balance between buyers and sellers has stabilized. The subsequent rise and the break of the double top have confirmed the resumption of the upward trend.
Retracements of 38.2%, 50%, and 61.8% are considered critical Fibonacci levels.
Dynamic Supports / Resistances
The S/R described above are static (specific price level). Traders often try to find dynamic support and resistance within the trend.
Moving Average Support and Resistance
Chart 4: Moving Average Support and Resistance. Source: MetaTrader4
During the upward trend in Chart 4, price declines met support around the moving average. When the trend turned downwards, the average started to act as resistance.
Of course, the choice of MA settings is subject to individual preference. Two different averages will give different results in an identical chart. Traders have to find the optimal MA parameters for their strategy.
Dynamic S/R gives the best results when there is a trend. During sideways price movement, they tend to generate numerous losses.
Trendline Support and Resistance
Chart 5: Trendline Support and Resistance. Source: MetaTrader4
The rising trendline provided support for short-term pullbacks in Chart 5. The formation of the top is indicative. Several attempts to continue the rise have failed. At this point, oscillators have probably signaled an overbought situation – an increased likelihood of a reversal. Gradually, the bears took control. During the decline, the downward trendline acted as critical resistance.
Other S/R Levels
The round numbers, for example, follow alternative logic to the methods mentioned above. The idea is that institutional investors position their orders around round values (e.g., EUR/USD 1.1000, 1.1100, 1.1200). The significant trading volume around these levels naturally turns them into key areas of support or resistance.
Pivot points are another way to determine essential S/R levels. They use historical price data to project critical prices.
Breakouts
Breakouts should be analyzed cautiously, as they are often false. Traders usually want to see additional confirmation that the respective resistance or support has been overcome. Many expect a closing price for the day above/below the resistance/support. Increased volumes would signal increased trading activity, validating the breakout.
Conclusion
Support and resistance levels serve as pivotal points for developing trading strategies. Various technical tools and methods are employed to identify these critical values. S/R levels can be static or dynamically changing. They act as trigger zones for opening positions or managing risk.
