The movements of the Forex markets are continuous, as buyers and sellers are constantly looking for opportunities to invest at different levels. One of the most popular ways to determine where to purchase and sell a currency pair is by using support and resistance. There are a plethora of ways to determine where the market will find support or resistance. These include using moving averages, trend lines, as well as Fibonacci retracements.
What is Supply and Demand
Support and resistance are key junctures where the forces of supply meet demand. The value of a Forex exchange rate is driven by a decrease in supply and an increase in demand. Supply and demand are driven by a constant flow from central banks, commercial banks, corporate hedgers, consumers, and speculators. As demand rises for a currency pair, an exchange rate will rise to create upward price pressure. As supply increases for a currency pair, the exchange rate will decline to create downward pressure.
What Is Support?
Support is an exchange rate level where demand is robust enough to prevent the exchange rate from falling further. This usually occurs when demand increases and sellers become exhausted and are less willing to sell at lower levels.
What is Resistance?
Resistance is an exchange rate level on a currency pair where the supply is thought to be strong enough to prevent the price from rising further. When an exchange rate reaches the resistance level, it is believed that demand is exhausted and supply will overcome demand and prevent the price from rising above the resistance.
What Happens When Support and Resistance Level is Met?
Support and resistance do not always hold. Many times there is a breakdown or break out below the support or above the resistance. A decline below support indicates a new willingness to sell and the lack of an incentive to buy. Support breaks and new lows signal that sellers have reduced their expectations of the value of an exchange rate and are willing sell at even lower prices. Additionally, buyers are unwilling to purchase a currency pair as the exchange rate declines below support or below the previous low. Once support is broken, another support level will have to be established at a lower level. The reverse is true for resistance. As prices breakout above resistance levels, sellers become less willing to sell and a new resistance level will need to be established to prevent buyers from continuing to push an exchange rate to higher levels.
How Do You Determine Support and Resistance?
There are several tools you can use to help you determine support and resistance. The most popular are:
- Moving Averages
- Trend Lines
- Fibonacci Levels
Support and resistance levels can be gauged by using a moving average. A moving average is the average of a specific number of periods. This could be daily, weekly, monthly or intra-day. To calculate a moving average, you initially generate an average of a certain number of periods. For example, a 10-day moving average is the average of the last 10-days. On the 11th day, the first day is eliminated from the average calculation. The charting software provided by Rakuten Securities Australia will provide you with any moving average period you are looking for on the MT4 charting software they offer.
You can see by using the 50-day moving average on the EUR/USD that there are times when the exchange rate will bounce off of the support, or retrace from the resistance. This is another technique that you can use to find support and resistance levels. Trend lines allow you to find the support and resistance using the slope of the change in the exchange rate. A trend line can be downward slope creating resistance. A trend line is drawn from a high to the next higher high creating the slope of a trend that determines resistance. A trend line can also be upward sloping creating support. A trend line is drawn from a low to the next lower low creating the slope of a trend that determines support. You can also draw a horizontal trend line that can be used to determine both support and resistance.
Another technique that can be used to determine the support and resistance is a Fibonacci retracement. This is a mathematic expression that helps define target levels of support and resistance. Your MT4 platform provided by Rakuten Securities Australia offers Fibonacci retracements as a popular study. The most common Fibonacci retracement levels are the golden ratios. These are the 38.2% retracement of the most recent move or the 61.8% retracement of the most recent move. You can see that the EUR/USD weekly chart is consolidating after reaching the 61.8% retracement of the down move that occurred from the highs in 2018 to the lows in 2020.
Why is Support and Resistance Important?
Support and resistance levels are important because they can describe levels in the market where an exchange rate will consolidate before either bouncing or continuing. You can use support and resistance levels to enter or exit a trade. A popular trading strategy is to use support and resistance levels to formulate breakout or breakdown levels. Additionally, support and resistance levels can be used to formulate your risk management. You can use support and resistance to determine levels where you will stop out of a position if you determine your trade will be unsuccessful. You can practice trading using support and resistance using a forex demo account provided by Rakuten Securities Australia.
The Bottom Line
To successfully trade in the Forex markets it’s important to understand support and resistance levels. These are regions of the market where supply and demand are equal. Support and resistance levels do not always hold. There will be times where support is broken and sellers are willing to sell at lower levels. For new support to occur, demand will have to resume. When resistance is broken, buyers are willing to purchase an exchange rate at higher levels and sellers become unwilling to sell until a new resistance level is met. There are several tools that you can use to determine support and resistance. These include moving averages and trend lines as well as Fibonacci retracement levels.