Almost any successful trader profiting on forex, has his own custom method of identifying two important market features, support and resistance. S/R zones can be horizontal, creating strong price levels that will strongly influence price development.
They could be also drawn as trend lines, creating tunnel. And they can be also found in wave structure of the price, as historical zones that were either penetrated by the price, or price bounced off them.
In this example, we can see market rising in a wave structure while creating support at the bottom and breaking resistances at the top.
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While market continues to rally, the lowest point reached before breaking previous high is support in the wave structure. The Highest point reached before correction swing down is resistance.
Support – Supporting price at the bottom. Price level that is strong enough to slow down or completely stop downward price movement. On the chart, it is represented as horizontal price zone. We draw it by connecting bottoms in the price.
Resistance – Resisting price to rise further up. Price level that is strong enough to slow down or completely stop upwards price movement. On the chart, it is represented as horizontal price zone. We draw it by connecting tops in the price.
Understanding support and resistance zones.
Supports and resistances, are not numbers, or exact price levels. Most of all they are price zones. Often times we can think that support or resistance got broken (breakout) while in reality, they were just tested by the market, barely penetrating the zone (fakeout).
Most of the times wick of the candle penetrates the zone, while candle fails to close above/below. Test temporarily penetrating support and resistance can be considered to be a fake out. Valid breakout of S/R can lead to substantial price movement in the direction of breakout.
So how can we tell if support/ resistance got truly broken.
We can consider S/R zone to be broken once price closes beyond it. We can also look onto forex volumes indicator and compare it to breakout candle. Typically, true breakout candle is accompanied with above average volume, while fake breakout (test, fake out) is coupled with low volume.
It also helps to think about supports and resistance like zones not lines our numbers. We always need to consider size and importance of S/R zones. S/R of lower importance (S/R in trend wave structure)may just slow the price progress, while most important S/R on higher time frames may completely stop and reverse even a major trend.
Drawing support and resistance as zones
To do so we can draw trend lines on candle chart, respecting both bodies and wicks of the candles, but also on line chart, using only price average.
Supports can become resistances and vice versa. Once price breaks either support or resistance, it tends to return back to that price level (zone) and test it. Once the tests becomes successful, previous support may serve as a resistance for the future price development (and vice versa).
Supports and resistance are one of the best tools of technical forex analysis. Lot of they potential however, still remains untapped. There is still a lot of traders that haven't learned to supports and resistances properly. Most of the times they try to make it fit they idea of the market, while they should just accurately describe the market.