Support And Resistance Level In Forex Trading

If you go through this article then you will be able to describe what is a support level? What is a resistance level? What is a role reversal of the support and resistance levels? How does market psychology affect the support and resistance level?

Support and resistance are one of the most basic and most misunderstood concepts in foreign exchange analysis. We know that the market is the meeting place of buyers and sellers. When both buyers and sellers interact with each other then we see certain zigzag formations in the forex chart. These formations hint at a meeting between the forces of both supply and demand. The upper part of the formation which looks like a mountain top is called “resistance” while the lower part of the formation which looks like trenches or mountains turned upside down is called “support”. Technical analysts consider support and resistance level as a crucial point that allows them to understand the delicate relationship between buyers and sellers and overall market psychology or sentiment. The break up in these formations indicates that the forces of demand and supply i.e. buyers and sellers have moved on and are now looking to form new levels of support and resistance.

The graph depicts support and resistance level

What is Support Level?
As described before “supports” are formations that look like trenches or mountains turned upside down. Lines that are looking downwards and form the lower side of the trenches indicate that sellers are pushing the prices of the currency pairs down but the demand or buyers remain adamant enough to drive the prices up. A support level indicates the presence of buyers. If you notice carefully, then you will see that there is a certain level below which prices cannot be pushed down further. It means sellers are not willing to sell below that level while buyers are there who are demanding an immediate purchase.

What is Resistance Level?
As described before “resistance” are formations that look like mountain tops. Lines that are approaching upwards and form the upper side of the mountain indicate that buyers are there who are pushing the prices up but enough supply exists which restrains the prices from going further upwards. Resistance level indicates the presence of sellers or suppliers. If you notice carefully, then you will see that there is a certain level above which prices cannot be pushed up further. It means sellers are more willing to sell and buyers are less willing to buy.

Market Psychology Behind Support and Resistance Levels
The market is a combination of buyers and sellers. As humans, those buyers and sellers are full of emotion and imagination. The simple demand and supply theory of economics is very much relevant in describing the support and resistance level but it also has a “sentimental” or “psychological” aspect to it. Let’s describe a hypothetical example to make things clear.

For the sake of simplicity, we will discuss the support area here. Suppose that the support here is $50. There are buyers who are purchasing and doing it very near or close to the support zone. After a group of buyers is done buying the price moves up to $55. Overall buyers are content and want to buy more but not at $55 rather a group still is there who want to continue buying at $50. They have decided to bid their time so that prices can be moved back to $50. By waiting they are creating the demand at the level of $50.

Another group of people exists and they are investors, not genuine buyers. These people are uncommitted opportunists. They were contemplating buying the product at $50 but never “actually bought.” Now the current price is $55 and they regret not buying it. They ended up deciding that if the price comes down to $50 again then they will buy this time. This creates potential demand.

The third group of market participants also exist and they are speculators. They ended up buying the product at $40 and when they saw that the prices had reached the level of $50, they quickly sold that product for easy bucks, only to see the prices rise further to a level of $55. Now they are thinking of going “long” again and purchasing the product at the selling value of $50. Here, they are the one who is making a potential reversal and changing the psychology from sellers to buyers. This act fuels more demand.

Now let’s turn the example upside down by discussing it in terms of “resistance”. Just assume that all sorts of market participants have bought the product at $50. The product has reached a level of $55 and a group of participants has not sold those. If the prices come back to $50 then they will start regretting it. After a while, all have seen that the prices have reached the level of $55 again and everyone has started selling their shares. In this situation, the price cannot go beyond $55 and will start retreating. This will create a resistance formation at the level of $55.

Support and Resistance Levels Role Reversal
A support and resistance level is not something that is written on the stone. The formations can be altered and the roles of the previous formations can be reversed. If the prices of the currency pair go further down the support level, then the new level will become resistance. On the other hand, if the prices of the currency pair go further up than the former resistance level then that former level will become support. Any alterations of the support and resistance level hint that supply and demand have shifted and changed course.

You must keep in mind that measuring and keeping an eye on the support and resistance level is a part of technical analysis. But this analysis should not be used in isolation. You must combine it with the fundamentals of the economy so that you will end up having a complete picture of the situation.