So, support and resistance levels are certain levels on a chart, beyond which an asset’s price seems reluctant to move.
Why are they important? Well, support and resistance levels are important and widely used in forex trading because they help traders anticipate the future movements of an asset’s price and identify good places to buy or sell. In other words, if you were trading the asset depicted in the image above, support and resistance levels would show you that points (a), (b) and (c) would be good opportunities for you to go long, whereas points (d), (e) and (f) would present good opportunities for going short.
Do support and resistance lines remain on the same levels forever? Of course not. Support and resistance levels change continuously and are often reversed, as shown in the example below:
As you can see, our asset’s price tested the resistance level (points 1, 2) twice. Once it managed to move beyond, what used to be the resistance level is now the support level (points 3, 4).
So, how do we know if our asset’s price is just testing a support/resistance level, or if it is about to break it?
We don’t. All that we know is that the more a price tests a specific support or resistance level without breaking it, the stronger this level is, though this does not mean that this level will never be broken or, even, that it will hold for much longer.
So, what we could do, is not place our order directly on the support and resistance levels, but wait to see the direction in which our asset’s price will move once it hits one of these two levels.
Placing our entry order just above the support level with a Stop Loss order just below it, or placing an entry order just below the resistance level with a Stop Loss order just above it, will help us make a calculated profit or minimise our losses if the price happens to move unfavourably:
Now, how can we take advantage of our asset’s price breaking past support or resistance?
If the price moves beyond the support level, as shown in the image above, we could wait for a bit to see whether this movement is decisive or not. By placing our entry order just below the support level but not directly on it, and by carefully placing a Stop Loss order just above the support level, we can benefit from the price falling below support:
Similarly, if the asset’s price breaks the resistance level, we place our entry order just above the resistance level and a Stop Loss order just below:
So, support and resistance levels are extremely important, not only because they help us identify the reversal of a trend, but also because they can help us detect the point at which to buy and where to sell. Of course, the forex market often moves unpredictably and in unforeseen directions, so determining support and resistance levels may not always be as easy. Knowing what these levels are and being able to detect them where possible, however, can significantly increase your ability to make informed decisions and calculated trades.