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Trading Rules for Support and Resistance

Just as there are  rules for trading Japanese candlesticks, there are also several rules you need to follow if you want to make wise trading decisions in the Forex market.

These rules are:

1. Draw your support and resistance lines.
2. Draw your trendlines. Remember: trade in the direction of the trend, because the trend is your friend. You want to be able to identify if the trend has been broken because you likely want to exit at that point.
3. Decide whether you will go long or short (based on overall trend direction).
4. Appropriately place your stop loss orders. For information on how to place stop loss orders when trading on support and resistance levels, see above. If the stop is too far away from your entry point the risk may be too great and you should consider passing on the trade.
5. Create a plan. Trade the plan. Traders get in big trouble when they become emotionally invested in a particular trade and so hang on too long to a losing trade. Even if you follow all of the trading rules and trade all of your indicators correctly, you will lose on some trades, just as any business takes losses as well as profits. By sticking to your trading plan you will maximize your profits and minimize your losses.

Past Resistance Levels can become Future Support Levels

As you read earlier, a bull wants to see the market achieve new highs, taking out previous levels of resistance and a bear wants to see the market taking out previous levels of support.

Sometimes past levels of resistance can turn into levels of support. This happens when the market has broken a the current level of resistance, but before it goes on to break the next level of resistance it bounces (bottoms) at the first level of resistance, which then becomes a level of support.

Eventually the market will break the support level (once a resistance level) instead of bouncing there, indicating a trend reversal. To trade in this situation, buy at the support levels and set your stop loss order at the last support.

Past Support Levels can become future Resistance Levels

Past levels of support can also turn into levels of resistance. This happens when the market has broken the current level of support, but before it goes on to break the next level of support it bounces (tops) at the first level of support, which then becomes a level of resistance.

Eventually the market will break the resistance level (once a support level) instead of bouncing there, indicating a trend reversal. To trade in this situation, sell at the resistance levels and set your stop loss order at the last resistance.

That concludes my basic overview of support and resistance for forex trading. This topic will come up when explaining future trades, so make sure you review the basics about support and resistance in the forex market until you fully understand them.

Posted in Technical Analysis

Support and Resistance in the Forex Market

Support and Resistance forms the foundation for any solid forex trading plan. Once you have a firm grasp of support and resistance in forex price charts, you’ll be head and shoulders above the average forex beginner (but will still be at the feet of the masters for now…)

Remember that the trading Forex market is a financial game, like tug-of-war, between the bulls and the bears. The bulls try to pull prices up and up, while the bears try to bring them down.

The market only moves in three directions: upward, sideways, or downward.
Highs

Highs are candlestick formations where the candle’s high point (usually the top of its upper wick, unless the candle does not have an upper wick in which case the high point would be the open or close) is higher than the previous two and subsequent two candles.

Levels of Resistance

Not all highs in the forex are levels of resistance, but all levels of resistance are highs.

In order to create a level of resistance, the market must be achieving higher highs.  The term resistance comes from the idea that at that price level, traders are resisting buying at the higher prices.

At the resistance level the bears sell enough and the bulls resist buying enough that an uptrend may be interrupted and reversed.

To identify resistance levels, start from the price the market is currently at (at the right of the chart) and work backwards (moving right to left) pinpointing higher highs.  Finding levels of resistance is like building a staircase that rises backwards, where each stair is a new level of resistance.

Lows

Lows are the opposite of highs.  They are candlestick formations where the candle’s low point (usually the bottom of its lower wick, unless the candle does not have a lower wick in which case the low point would be the open or close) is lower than the two previous and two subsequent candles.

Levels of Support

As with highs, not all lows in the forex are levels of support, but all levels of support are lows.  In order to qualify as a level of support, the low must be lower than the previous low.

Support is a low and a price level where the bulls start buying enough to interrupt and reverse a downtrend.

In order to identify support levels, start from the price the market is currently at (at the right of the chart) and work backwards (moving right to left) pinpointing lower lows.  These lower lows are levels of support.  Draw a line at these lows to the left until you hit the next candle, then look for the next lower low (the next level of support).

When the market achieves lower lows (creates a new level of support) it is said to be breaking support.

If you are a bull then you want to see the market making higher highs, taking out previous levels of resistance.  Set your stop loss order at the last low or the last level of support.  If you are a bear then you want to see the market making lower lows, taking out previous levels of support.

In this case, set your stop loss order at the last high or the last level of resistance.

Understanding the basics of support and resistance forms a large part of the foundation needed to become a successful forex trader. In my next blog post, I’ll give you some trading rules for interpreting forex levels of support and resistance.

Posted in Technical Analysis