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Saturday, December 14, 2013

Forex Trading, Technical Analysis - Support and Resistance

Establishing well-defined support and resistance zones is a key element that will help us have better trading results. Here are a few questions and answers that will help you gain a better understanding of the use of support and resistance zones.

Is there an exact level where support and resistance levels should be placed? 

No, as we have already seen, support and resistance are more like “zones” rather than “levels”. It is common however to place resistance zones just above price action and support zones just below price action, but some traders put them at or near price action. At times, it is difficult to find the exact level of support or resistance; in these cases it is valid to place support and resistance zones near price action (like we did in charts 1 and 2). 

What different methods exist to define support and resistance zones?

Based on Previous highs or lows
                                                  When ever the market approaches to previous highs or lows it has the potential to act as a resistance or support (you will see this in the next lesson on chart patterns). 

Round Numbers
                                    Many experts and bank traders put their orders at round numbers (entry orders or take profit orders) because there are so many orders around these levels that the market sometimes has some trouble getting through them. These levels tend to have a psychological support and resistance zones. Round numbers are 1.4500 or 1.0000, etc. 

Based on Moving Averages
                                                A moving average is a technical indicator that could be useful to determine support and resistance areas (we will see MA in more detail in the following lessons). 

Based on other technical indicators
                                               Other technical indicators can also be used to determine possible support or resistance areas, en example would be Fibonacci Retracements.

From the methods above, which one is more effective?
There is no correct answer for that question. Sometimes one methodology forecast support and resistance levels better than the other ones. What I recommend you is to see what is the market’s feel each day of trading, and see what is working for that particular day (i.e. there is no case to use round numbers as support or resistance if the market is not taking them in consideration).

What are false breaks?
Take a look at the chart below:
False Break

This chart is the same one as Chart 2, take a close look at what happen in the red oval, the market actually traded above the support zone but it bounced back. This is what we call a false break: the market fails to trade consistently above/below a resistance or support zone.

Whenever the market approaches to a support or resistance zone, what should I do?
That depends in your situation. Here are a few scenarios:
- If you have no open positions and intend to go long, if the market approaches to a support zone, try to find a long signal.
- If you have no open positions and intend to go short, if the market approaches to a resistance zone, try to find a short signal.
- If you have a long position and the market approaches a resistance level, try to find an exit signal.
- If you have a short position and the market approaches to a support level, try to find an exit signal.

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