Learn Forex #2 - Support and Resistance

I’ve gotten a lot of requests recently to explain in more detail my trading signals and the trading fundamentals behind them.

Over the next few months I will be releasing several articles about the trading fundamentals behind my forex signals and analysis. For example, what I mean when I say “Sell Rallies”, “Buying Dips”, “Approaching Support”, “Look for bullish reversal signs”, etc., etc. I have already released one article a few months back on forex money management if you haven’t read it.

If there is something that I am missing be sure to send me a comment at the bottom of the page or use the “Contact PipHut” link to the left.

Here we go!

Support (Signal: “Buying Dips”, “Approaching Support”, etc.)

Support is, simply put, a price at which point traders expect to see buying. Support can be a level that we have seen previous buying activity at (perhaps the price bounced off of it last month), psychological (a great example here is the USD/JPY pair, which had major psychological support at 100.00), or, for more advanced traders at options locations.

In this article we will be discussing the first two of these options as the last one takes a more advanced understanding of the markets – and quite simply a major bank’s options data is not available to most people.

Support example #1: “The Signal”

The most common place for support level is an obvious spot where traders have seen a major reversal in the past. For example, take a look at example #1 above. Do you see the red horizontal line at 1.5715, right underneath the blue arrow? If we look back in the week we can see that the pair broke through this level on the 24th, only to fall back down and bounce off of it on the 25th. By bouncing off that level we can tell a couple of things about the future of the pair.

First is that traders expect the pair to return to the upside. We can tell this just by the fact that we had substantial buying at that level. Second we can tell that the pair is in an obvious upswing since early June. Unlike the previous rise in early June (which ended by dropping very sharply over the next few days) this rise has been a steady, deliberate act. This tells us that both bears and bulls are out in full force but the bulls are winning and pushing the pair higher and higher.

Finally now that we have seen that traders were buying around this level in the previous days we can reasonably expect (unless there is a major change in fundamentals) that we will still have buyers around this level and will look to “buy dips”.

Lets take a look at the below chart to see what happened with the pair after this signal was posted:

Support example #2: “The Result”

Look at that! The pair bounced off our support level at 1.5715 and rose over 170 pips to hit 1.5890 within a few days. Not bad for a 30 minutes of chart analysis!

Resistance (Signal: “Selling Rallies”, “Fading Rallies”, “Approaching Resistance”, etc.)

As you might guess, resistance is the exact same as support except it is an area where we have seen traders selling the pair in the past.

Resistance example #1: “The Signal”

First is always to indentify the direction in which the pair is trending.  In the above chart it is difficult to tell. The pair has most recently closed roughly where it began after taking a major dip and then workin its way back up. In that case we would back out to the daily view to get a better feel for the trend and see that the pair was trending down at this time. Knowing that the pair is trending down we are biased towards short selling opportunities.

We can see that the pair, after an initial pierce, dropped to below 1.4765. The pair ranged below that resistance level but was never able to break it again. Knowing that we are in a downtrend that area becomes a resistance area and I issued this selling signal above.

Had we followed that signal and sold the pair at that level lets take a look at how the trade would have fared for us:

Resistance example #2: “The Result”

Look at that! After hitting our sell signal at 1.4765 the pair quickly found sellers that pulled the pair down to 1.4300 – a quick 465 pips off of a simple “sell rallies” signal!

As with any trading in the currency exchange market these signals need to be combined with over indicators as well to help confirm the trade and to make the odds of a successful trade more likely for you.

And, of course, solid risk management strategies must be employed. For more information on risk management and money management techniques see Lesson 1: Money Management. As always, my goal is not to trade for you – it is to help you learn how to trade better and learn for yourself!