If you are new to the forex markets and currency trading then I have no doubt that you may already have come across the terms “support” and “resistance”. They are pivotal to your successful trading. It is critical to understand what causes them, and how to spot these areas of support and resistance on your currency charts.
In the normal cycle of the forex market the price is influenced completely by sellers and buyers. If there are more sellers than buyers at any given period then the price will be moving downwards. Conversely, if there are more buyers than sellers at any given time then the price will be moving upwards.
To keep this tutorial short I will only discuss “support”, and you can take the inverse of this information as the cause “resistance”. For the purposes of our explanation here lets also assume that the price in the market is falling – it is a bearish market.
Support is going to be caused by a LOT of buy orders waiting in the market at, or around, a particular level, below where the price is currently. Nobody ever knows where other traders buy orders are laying in wait, but there are many reasons why such a volume of buy orders may be waiting at a particular level.
“Round” numbers are often points to watch. For example, a very round numbered price like 1.5000 on the EUR/USD may well be a place that bigger players (central banks, and funds) would place orders. Also, big players may place orders ahead of their option strikes, in an attempt to defend them should the market approach those levels. The reasons are too many to mention, but you just need to be aware that, at certain levels, a falling market will encounter some serious “opposition”.
The shear volume of these buy orders may well be strong enough to overcome the number of sell orders causing the price drop, and the price will battle to break below this level of buy orders. In fact the buy orders may be of such a volume that they completely overcome the sell orders and the price “bounces”, or even reverses direction.
This level of STRONG buying is known as a support level, or an area of support.
Think of it this way – if you jump off the roof you begin to fall. At some stage you are going to hit the ground. If the ground is hard, it will be tough enough to stop your fall. It offered you “support”.
Why is it so important to your trading that you be able to spot these areas of support?
Well, you do not want to take a short trade just before a support level. There is a good chance that the price action may bounce, and stop your trade out for a loss. Instead, you rather want to wait and watch the price action around that support level. Then enter your short trade only once that level of support gives way, and the downward momentum in price continues.
Keep your currency trading plan simple.