Risk and reward must be balanced in order to be traded profitably on the forex market. It is possible due to the use of special algorithms.
This post will discuss support and resistance indicators, the significance of support and resistance zones, and how to use them to trade profitably.
Key facts about forex level indicators
Technical analysis in the currency market includes indicators for support and resistance. Market participants can trade currencies with greater accuracy thanks to these algorithms.
The indicators indicate overall patterns in the FX market based on the supply and demand situation during a specific time period.
Let’s look at the important terms that are related first:
1. Levels are important points for the asset when bulls and bears are almost evenly balanced. A correction slows down or stops altogether in these areas. When the asset reaches these levels, it is highly likely that it will change course, depending on whether bullish or bearish traders decide to lead the market.
2. A support level is a horizontal line that connects several swing lows of an asset. Bulls start to reclaim control of the market from bears as soon as the asset declines in value. Support lines show an instrument’s lowest price and act as a barrier to the instrument’s decline.
3. In contrast, a resistance level marks the asset’s peaks. Bullish traders give way to bearish traders when the instrument pushes up against this line. The strength of the level increases as the asset tests the resistance and bounces off it more frequently.
4. Indicators are mathematical algorithms built on facts regarding the asset. These instruments are used to evaluate the quote’s historical performance and predict its price trends.
Although the forex market is purely virtual, the price dynamics of its assets are determined by actual people—bulls and bears. Bearish traders believe a currency will decline, while bullish traders expect a currency to increase.
During the trading session, bulls and bears compete for dominance to secure their investments, breaking the supply and demand balance.
When the asset reaches the resistance level, bulls actively start opening long bets. At support levels, bears close out their short positions and sell the asset.
Trades made by important market players have a big impact on the market and can even establish new significant levels.
How it functions practically
When we look at a currency pair’s chart, we can see that its price is always changing.
Beginner traders can assume that the price of the pair moves randomly and without adhering to any patterns. However, this is not the case.
The pair has reached its support range when it moves to a particular point and then rebounds upwards.
The instrument’s support level becomes stronger the more times it is unable to break it.
When this occurs, the instrument has reached its resistance level, similar to when the pair reaches its high.
A trend reversal is indicated by the currency pair’s frequent bounces off this level and downward movement.
The boundaries of these levels become more exact when the pair tests its support and resistance levels more frequently. This enables traders to observe the pair’s price dynamics over time.
In addition, crucial psychological levels include the support and resistance zones. Market participants prefer to conduct trades within their own boundaries, thereby reinforcing these levels.
Trading requires knowledge of support and resistance levels. The instrument will probably fall if it gets close to the resistance level. Bears must open short positions in this circumstance.
Similar to this, bullish traders enter the market when the quote approaches the support level.
Traders must search for signs of a trend reversal, such as reversal patterns, when examining the movements of the instrument.
When a quote is tested for support or resistance, it can break through these levels and reach new ones.
In order to avoid errors, traders must check for candlestick patterns, indicator data, and other signs.
For the following tasks, support and resistance levels are used:
- Identifying the direction of the price,
- Identifying the ideal level for placing a stop-loss order;
- Estimating a trade’s possible profit.
While some market participants operate within the price channel created by support and resistance levels, others utilize these levels in a variety of ways across a range of time frames.
Tips for trading with support and resistance
Support and resistance levels are the foundation of many trading systems used by both new and experienced traders. These methods are only effective if the trader sets the proper risk/reward ratio and correctly identifies support and resistance levels.
A trader must carefully examine their trading plan and faults in order to meet these requirements. It should be noted that support and resistance are crucial in times of increased market activity, especially following significant news, as well as times of higher trading volume and volatility.
A significant level may also be indicated by large market participants placing substantial orders in the book order. Low trading volume might cause an instrument to drift between levels of support and resistance without displaying any trend signals.
In this circumstance, traders must use caution and treat important levels as a price range rather than a fixed price level.
Other factors to consider when trading with support and resistance are as follows:
1. Constantly await confirmation of the level. A market participant has to know whether the price performed a breakout or rebounded off the level.
Otherwise, trading breakouts would be quite dangerous.
2. If the price swings upward after rebounding from its support, you should start placing short bets;
3. If the asset’s support level changes to the new resistance level following a breakout, it is time to sell the asset.
4. When the price bounces off the resistance level to the downside, short trades can be opened.
5. You should go long on a currency pair if the previous level of resistance turns into the new level of support following a breakout.
6. When opening short positions, stop-loss orders must be placed above the resistance; for long positions, they must be placed below the support.
The following trading strategies take advantage of support and resistance levels:
When the instrument is in a sideways trend, bounce trading is most frequently used. When a currency tests its support level, traders open long positions in it, and when it reaches its resistance level, they open short positions.
In this case, stop-loss orders are placed with long positions below the support range and short positions above the resistance.
Traders can profit immediately when the quote bounces off significant levels. They might, however, change the stop-loss order and wait for a larger bounce.
When the quote crosses the important zone, breakout trading is employed. Breakouts typically occur when there are significant economic developments and times when trade volume is higher.
In this case, the price moves in the direction of fresh extremes, which traders take into account while preparing new trades.
The wisest course of action in this scenario, according to seasoned traders, is to wait for a short while. You should wait for the price to drop even more when the quotes test the support.
You don’t have to stick with just one method; you may combine bounce trading and breakout trading.
Everything depends on the state of the market, the precision of the forecast, and the preferences of the trader.