Forex Price Action Basics - Lesson 7: Support and Resistance
Previous lesson, Forex Price Action Set-ups...
So far in this Forex price action course, we have covered the basics of Japanese candlesticks, trending markets, ranging markets and price action set-ups. If you need a refresher on any of these topics, please go back and read and watch the needed lesson again. By now, you should know how to identify the high, low, open and close of price using a Japanese candlestick, understand chart time frames, know of downtrends and up-trends, identify the swing highs and lows of a trend and understand the basic of price action set-ups, including engulfing candles, pin bars and other setups.
This lesson will cover support and resistance. Support and resistance is possibly the most used price action phenomenon in Forex trading. It helps traders, investors and analysts, to pinpoint potential areas of price reversal and is considered one of the most reliable forms of technical analysis.
What is Support and Resistance?
Support and resistance are price levels within the Forex market that price has historically reversed. Support and resistance is used to identify potential areas of technical and psychological importance. Knowing of these areas can help a trader to predict future price reversals. One of the many things that I have learnt over the many years that I have been trading Forex, is that what price has done in the past, within a financial market, will likely happen again. For example, if the EURUSD climbs to a price of 1.2500 and sharply declines from this level, it is likely that next time the EURUSD climbs to 1.2500, price is likely to see some decline again. To demonstrate this principle, please check out the AUDUSD daily price chart below...
Do you notice that price reversed at a certain level in October 2015? What happened when we reached that level again in December 2015? Price reversed again. Hopefully from this example you can see how important and profitable it can be to identify areas of historic price reversal for potential future price reversal.
When these potential reversal levels are under price, they are referred to as support levels - they support price and hold price up! Below is another price chart, I have marked the support levels with a horizontal line and have highlighted when the support is reached and price reverses.
When the potential reversal levels are above price, they are referred to as resistance levels - they act as a resistance or barrier to upwards price action. Below is another Forex price chart, I have marked the resistance levels with a horizontal line and have highlighted when price reaches the resistance and reverses.
Support becomes Resistance, Resistance becomes Support
Eventually price will move below a support level and above a resistance level, this is usually referred to as a break or breakout. When support is no longer valid and price has moved below the support level, the level can then act as a resistance level. When resistance is no longer valid and price has moved above the
resistance level, the level can then act as a support level. Perhaps the charts below will teach this better than I can with words...
Can you see the resistance level marked by the red line? When the resistance is broken, you will notice that the previous resistance level now becomes a support level.
The chart above illustrates a support level that becomes a resistance level.
Trend Support and Resistance
In Forex trading, support and resistance areas don't always have to be horizontal levels, they can also be diagonal. Below is the same AUDUSD daily chart that I used at top of this page. Do you see the diagonal support line? Do you notice that price continually reverses each time this support line is reached?
Support becoming resistance and resistance becoming support is also evident with diagonal support and resistance. Check out what happens to price on the AUDUSD when the previous diagonal support is met...
Floors and Ceilings...
An easy way to remember the price action principle of support becoming resistance and resistance becoming support, is to visualise a block of apartments or a high-rise office suite. Think of being on a particular level of the building, the floor (support) is beneath you and the ceiling (resistance) is above you. When you take the stairs or elevator to a floor higher, the previous ceiling (resistance) is now your floor (support). When you take the stairs or elevator lower, the previous floor (support) is now your ceiling (resistance). This allegory of floors becoming ceilings and ceilings becoming floors demonstrates how support turns resistance and resistance turns support.