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Lesson 7: Support and Resistance

Two common terms that you will find in
trading-particularly in technical analysis-are’ support’ and’ resistance’
levels. But what do these terms mean, and how do they apply to your business?

Support

The level of support is found below the
current price of the instrument and tends to be where falling prices find a
support floor. This means that the price is more likely to’ bounce’ off this
level than to break through it. For example, when you find that a market has
trouble breaking below a specific level, which means that you have found an
aid. The general rule is that the level of support helps to prevent prices from
dropping even further, i.e. providing market support. Support levels occur for
a number of different reasons-essentially, they attract buyers back to the
market as a psychological level. The price of this market should not fall any
lower, so I’m going to go long.’

Resistance

A resistance rate is placed above the
current price of the commodity and serves as a price ceiling as it increases.
Contrary to the level of support, the level of resistance means that the price
is more likely to fall away from this point than to break through it. The
general rule of resistance levels is that they tend to stop prices from rising
further and to serve as a price ceiling of resistance. Essentially, traders are
motivated to lock in their positions and draw sellers back to the market. I
don’t think the market is going to get bigger, so I’m going to close my place
by selling.’

How to recognize support and resistance
There’s a wide range of resources and analytical methods that help to identify
support and resistance rates, including:

  • Previous
    tops and bottoms
  • Candlestick
    patterns
  • Moving
    averages
  • Trend
    lines
  • Bollinger
    Bands
  • Fibonacci
    retracement

Levels
to Watch

When support/resistance levels are broken,
a breakthrough or bounceback usually occurs, until another support or
resistance level is found. For example, EUR/USD may find it difficult to break
above 1.15. It may test this barrier two or three times before it bounces back
below, or it may eventually break through.

A bounceback
is a condition in which the asset recovers from the level defined as a
resistance or support. Look at the chart below: it was hard for WTI to reach
more than $55 per barrel of oil. The market rebounded a few times from the
point and went back down, bringing the product $7 lower over a relatively short
period of time.

While a bounceback is more likely than a
turnaround, it would be a warning that the economy can at least reverse trends
in the short term.

A breakthrough
is an important trading moment, as it usually leads to a rapid increase in volatility.
As shown in the graph below, the pair struggled to break under 1.35, but a
quick move occurred after it finally managed to do so.

In addition, after the support level is
broken, a new level of resistance is formed, and when the resistance level is
broken, the support level becomes.

Take a look at the USDMXN. 20.00 was a
critical point that many traders were looking at. Upon breaking over it, the
pair rose 2 additional figures and hit an historic high of 22.00. Nevertheless,
a downturn has begun since then. The USDMXN broke below 20.00, retested it (a
aid converted to resistance), failed to break higher and then began its lower
march. This is a typical situation worth looking for, as it gives traders a lot
of opportunities to join the trend. In such a case, the trader could have sold
the pair after it had retested 20.00.