Knowing how to identify support and resistance levels is essential to being a good trader. Knowing these levels allows a trader to know when to open or close a trade, what trade to make (whether a buy or sell) and when he should be cautious in entering the market.
As you may have guessed, it is mainly technical traders that use support and resistance levels. Generally, fundamental traders are too focused on studying economic information and financial conditions of the industries that they believe will affect price, to worry about these levels. The easiest way for technical traders, or anyone to identify support and resistance on a price chart, would be to look for the zig zag patterns.
The Zig Zag
The easiest way to identify a support or resistance level in FX trading is to look for the obvious area where price bounces back. These are areas on price charts, where price will not cross.
Now for an example on a real chart.
The green line represents the area of resistance, where the price creates a ceiling that it will not break above. The price highs are indicated by the red circles.You can see that they bounce back from the green line.
Areas of support can be seen where price creates a floor that it will not go below, and instead price bounces up from.
The red line on this weekly chart marks the area of support. The blue circles indicate the price lows that do not break below the price floor created by the support level.
Now, so far, while these have been easy to spot on a chart, they are not the only types of support and resistance. Trends are formed whenever you can observe the market making either higher highs and higher lows or lower highs and lower lows.
An uptrend or bullish trend is formed when the market forms higher highs and higher lows. A higher high means that when the FX market makes a move up, and then price pulls back and finds support, the next high that is formed when price moves up again is higher than the last area where price peaked.
Higher lows are similar, and simply indicate what occurs when the low that forms when price pulls back, is higher than the low that was formed before. Here on this daily chart, we can see the higher highs marked in red, while the higher lows have been marked with blue. Their formation indicated a small uptrend that was broken when the price formed a resistance level (highlighted in green) that price would not go above.
The opposite of this is the down trend or bearish trend that is formed by lower highs and lower lows.
The lower highs are shown by the blue circles while the lower lows are indicated in red.
It is important to remember that price is not always exact. Sometimes price may go a little below the support line and then bounce up. Sometimes it may go a little above the resistance line and then bounce down. A good trader does not use support and resistance alone to make trades but uses it in combination with other methods.