How Traders Use Support and Resistance Indicators in Trading Strategies
In the dynamic realm of trading, traders employ a variety of tools to navigate the continually evolving market landscape. Among these, support and resistance stand out as pivotal instruments, aiding traders in understanding important price levels on the charts. This article seeks to explore the indicators for support and resistance, offering insights into how they can be used to analyse market changes.
Why Traders Use Support and Resistance Levels
By effectively utilising support and resistance trading strategies, traders may enhance their decision-making processes. Here is why traders use these trading tools:
- Entry Points: Support and resistance are crucial in identifying optimal entry points for trades. When the price approaches support, traders anticipate a potential upward reversal, providing a buying opportunity. Conversely, when the price nears a resistance, traders may look for signs of a downward reversal, indicating a potential selling point.
- Trend Identification: The levels may aid in identifying market trends. When the price consistently finds support at higher levels, it indicates an uptrend. Conversely, if the price continually hits resistance at lower levels, it suggests a downtrend. When the price rebounds from horizontal levels, it indicates a consolidation range.
- Stop Loss and Take Profit: Support and resistance help traders determine where to place their stop-loss and take-profit orders. By setting a stop-loss just below/above support/resistance, traders can potentially limit their losses if the price breaks below support/resistance. Similarly, placing a take-profit order just below/above a resistance/support may help secure potential returns before a market reversal.
Trading Support and Resistance Levels
Support and resistance act as psychological barriers where price action tends to stall, reverse, or accelerate. Here is how traders may trade with them:
- Reversals: Trading reversals involve implementing the entry points concept mentioned above. For instance, if the price bounces off support, traders might enter a long position, expecting the market to rise. Conversely, if the price reverses at resistance, traders might enter a short position, anticipating a drop.
- Breakouts: Breakout trading occurs when the price moves decisively through support or resistance. Traders enter trades in the direction of the breakout, expecting the market to continue moving the same way. A breakout above resistance may signal the start of an upward trend, while a breakdown below support could indicate the beginning of a downward trend.
Support and Resistance Indicators
Various technical indicators are used to identify the major support and resistance points. The TickTrader trading platform by FXOpen has all the major indicators needed to find these levels on a chart. Let us go through the most popular ones in detail and explain how traders can use them.
Pivot Points
Pivot points are a popular technical indicator used in trading to analyse market trends and strong reversal points across various financial instruments, such as stocks, currencies, and commodities. Although there are many types of pivot points, the main idea is that they are calculated using the high, low, and close prices of the previous trading period to determine key levels: the central pivot point, support, and resistance.
How to Use Pivot Points
Traders may use the pivot points for the following:
- Breakout Trading: A bullish breakout involves entering a buy trade when the price breaks above the pivot point (P) or the first resistance (R1) and closes above it, targeting the next resistance (R2). Conversely, a bearish breakout involves entering a sell trade when the price breaks below the pivot point (P) or the first support (S1) and closes below it, targeting the next support (S2).
- Reversal Trading: A bullish reversal strategy involves entering a buy trade when the price stalls above S1 or S2 without breaking below it, with the pivot point as the first target. Similarly, a bearish reversal strategy involves entering a sell trade when the price stalls below R1 or R2 without breaking above it, targeting the P level.
Fibonacci Retracements
Fibonacci retracements are based on the Fibonacci sequence and the Golden Ratio, used by traders to identify potential support and resistance points. The Fibonacci sequence starts at 0 and 1, with each subsequent number being the sum of the previous two. Key ratios derived from this sequence, such as 38.2%, 50%, and 61.8%, are used to determine key market points.
How to Use Fibonacci Retracements
These are the most common ways to use the Fibonacci retracements:
- Trend Continuation: In trending markets, Fibonacci retracements are essential for identifying potential support and resistance points. In an uptrend, the market often pulls back to the 38.2%, 50%, or 61.8% level before continuing its upward movement, with these points acting as support. Conversely, in a downtrend, the market typically retraces to these same levels before resuming its downward trajectory, where they serve as resistance.
- Reversals: Traders combine Fibonacci retracements with other technical analysis tools like candlestick patterns (e.g., hammer and shooting star) and chart patterns (e.g., triangles and wedges) for additional confirmation. You may monitor how the price reacts at the Fibonacci retracements. If it closes through the Fibs cleanly, it's less likely to reverse. If it shows signs of rejection (e.g., long wicks), the level is more likely to hold.
Moving Average
Moving averages (MAs) are some of the commonly used indicators. They have many use cases, including identifying support and resistance points. MAs calculate an asset's average price over a specified period, continuously updating and recalculating as new data points become available. This allows them to smooth market fluctuations. Also, the MA is a lagging indicator, which allows it to provide insights into trend strength.
How to Use Moving Averages
Moving averages are versatile tools and can be used in various ways to potentially enhance trading strategies.
- Support and Resistance: The MA acts as a dynamic support/resistance based on the price position relative to it. Traders consider it support if the price is below it and resistance if the price is above it.
- Crossovers: Crossovers between two MAs with different periods can help traders strengthen the signals of the support/resistance levels as they reflect changes in market sentiment and potential trend reversals.
Donchian Channel
The Donchian Channel indicator is a straightforward yet powerful tool for traders. It consists of three lines on a chart: an upper boundary (highest high over N periods), a lower boundary (lowest low over N periods), and a midpoint line ((Upper Boundary + Lower Boundary) / 2). Typically set to 20 periods by default, N can be adjusted to increase responsiveness or reduce noise based on market conditions.
How to Use the Donchian Channel
Traders may use the indicator as follows:
- Trading Breakouts: Upper and lower boundaries serve as support and resistance. Traders look for the price breaking above the middle line to open buy trades and close them near the upper boundary and vice versa.
- Identifying Reversals: Traders may close long positions near upper boundaries and short trades near lower boundaries before the market reverses. Multiple touches increase the strength of support and resistance.
Bollinger Bands
Bollinger Bands consist of three lines: a middle band (typically a 20-period simple moving average), an upper band (20-period simple moving average + (20-period standard deviation of price * 2)), and a lower band (20-period simple moving average - (20-period standard deviation of price * 2)). These bands adjust based on market volatility, expanding during periods of high volatility periods and contracting during periods of low volatility.
How to Use Bollinger Bands
Traders may use the Bollinger Bands to determine entry and exit points as upper and lower bands serve as support and resistance:
- Trend Trading: Traders can buy near the lower band in an uptrend and sell near the upper band in a downtrend.
- Range Trading: Traders look for buy signals near the lower band and sell signals near the upper band when the market consolidates within a narrow range.
Final Thoughts
Incorporating support and resistance analysis alongside fundamental analysis is crucial for a well-rounded market perspective. Remember, trading carries inherent risks, so it's vital to employ effective risk management strategies. As you refine your analytical approach and gain confidence in your trading abilities, consider leveraging your strategy across 600+ instruments by opening an FXOpen account.
FAQ
What Is the Support and Resistance Concept in Forex?
Support and resistance in forex refer to levels where a currency pair often encounters barriers to moving lower (support) or higher (resistance). These are crucial for traders in making decisions about entering or exiting the market.
How Can I Find Support and Resistance?
To find support and resistance, traders analyse historical data. They look for areas where the price repeatedly reversed or stalled, often using tools like trendlines, pivot points, and moving averages.
How Can I Identify Strong Support and Resistance?
Strong support and resistance are identified by multiple price bounces or reversals occurring at the same level over time. The more times the market has reacted at a particular level, the stronger that level is considered. However, it may also mark that point as prone to breaking in the future.
How Can I Trade Support and Resistance?
Trading support involves buying when the price approaches this level with the expectation that it will bounce higher. Trading resistance involves selling when the price approaches this level with the expectation that it will reverse lower.
Is Supply and Demand the Same As Support and Resistance?
While related, supply and demand zones and support and resistance levels are not the same. Support and resistance focus on specific levels where buying (support) or selling (resistance) pressure is concentrated, whereas supply and demand zones encompass broader areas influenced by market orders.
Read more: https://fxopen.com/blog/en/how-traders-use-support-and-resistance-indicators-in-trading-strategies/
Text source: Forex Trading Blog
