Forex Trading Price Action: Support and Resistance
Most Forex traders quickly come to realise that trading price action is most profitable at major support and resistance areas.
After all, the outcome of price action in these areas is likely to determine the next market trend, so it makes sense to start taking positions near them.
However, most people don’t do this correctly. They simply try to enter on a bounce or a breakout, which is an ineffective way to trade off support and resistance.
In fact, there’s a much better to trade Forex price action at support and resistance areas, and in this article I’ll show you how.
Let’s start with the fundamentals…
Defining Support and Resistance
There are two ways to determine support and resistance areas: via price levels and trend lines.
Price level support/resistance is drawn horizontally on the chart. It can be based off swing highs and swing lows, or at psychological round numbers. Often, these two regions will coincide.
In the chart above, the blue support and resistance lines are set at swing highs/lows, while the green lines are set at round numbers. Notice how closely they tend to be situated to each other.
This type of support/resistance is the more reliable of the two.
Next, let's look at trend line support/resistance.
These are drawn diagonally on the chart and are based off swing highs and lows in trending markets.
In this chart, the red lines depict the diagonal resistance trend lines and the blue lines depict the diagonal support trend lines.
Notice how market prices do not respect this type of support/resistance as reliably as price level support/resistance. (Don’t take my word for it, pull up a few charts and see for yourself.)
- In my daily trading, I don’t take trend line support/resistance too seriously. Instead, I plan most of my trades according to price level support/resistance.
Price Action at Support and Resistance: Breakout
There are only 2 ways to trade at support/resistance areas.
The first way is with a breakout.
Most retail traders define a breakout as a close above a resistance area, or a close below a support area.
Here’s a textbook example:
At this point, most amateurs would sell upon the close of the breakout candle.
For 90% of such situations, this would be a poor entry point because we have not yet seen the market reaction to the breakout. Only in rare circumstances would market prices continue to move in the direction of the breakout right away.
More likely, the bulls will continue to fight it out with the bears, and this is when we want to be paying close attention. We want to trade the reaction to the breakout, not the breakout itself.
After the support/resistance breakout, we might see an immediate reversal as the bulls turn around to overpower the bears, resulting in a false breakout.
More often though, we’d see some kind of consolidation where both sides continue to fight it out. How we interpret this price action “struggle” then dictates where we should be entering the market, and in which direction.
In the chart below, we see a consolidation after the initial breakout:
Notice how the sellers have managed to keep prices below support. This means that the buyers remain weaker than the sellers, and that we can now start looking for a place to sell.
Breakout entry point
Now we have decided to sell this market, where should we sell?
There are two options.
The first and more aggressive option is to set a sell limit order at the retest of the support-turned-resistance.
The stop loss can then be set either above the breakout candle, or above the previous swing high.
The more conservative option (which is what I prefer) is to set a sell stop order below the low of the consolidation.
This way, I will only get into the market when the buyers give way to the sellers. The stop loss will be set up above the consolidation.
Here’s what happened next:
Here’s one more example that explains how to trade off price action upon a breakout. See if you can identify the 2 entry options.
Price Action at Support and Resistance: Bounce
The second way to trade support/resistance is to wait for a bounce off that level.
In the chart below, we see a support level being tested a third time:
Upon the close of the latest candle, amateur traders would be eager to buy right away.
Experienced traders on the other hand, know that buying at this point is too risky, since prices are still close to the support area. After all, the next candle could very well lead to a breakout!
The smart thing to do here would thus be to be patient and wait for a reaction to the bounce.
Now, we see the latest bullish candle close convincingly above the opening price of the test candle. This is the bounce confirmation that we’ve been waiting for.
We can now take a buy trade with a stop loss below the test candle:
Here’s what happened next:
The Bottom Line
These are two of the most reliable ways I’ve found to trade off price action at support and resistance levels.
The key thing remember is to first wait for the market’s reaction after a breakout (or bounce off) support/resistance, rather than to enter the market immediately.
Let the price action of the reaction tell you the true strength of the bulls vs the bears, and only enter the market after you see a confirmation of the breakout or bounce.
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