Technical Analysis: Support and Resistance

Support and
resistance is THE most popular and used technical analysis concept. It’s based
on the fact that price tends to react to certain levels and those same levels
can be traded as the price gets rejected.

So, if traders expect a level to hold,
they will trade that level making all this process kind of a self-fulfilling
prophecy. When you sell a level, it’s called resistance, when you buy a level,
it’s called support.

Since other
traders pay attention to this concept, it makes it a valuable tool, but you
should first have a fundamental directional view because if the market is in a
downtrend due to clear reasons for selling a certain currency, the support
levels will provide maybe just a profit taking reaction if not being useless at
all, while resistance levels will be used to sell the currency for a continuation
of the trend.

The most popular way of drawing support and resistance on a chart
is by identifying levels where the price reacted the most.

However, as
you will see many times, different traders have different levels, this is
because it’s highly subjective, that’s why a better way is to think about these
levels as zones of interest rather than exact price levels.

Another more
practical and useful way is to look only for the most recent levels as if
you’re following the flow, just like for fundamental analysis old news become
irrelevant, for technical analysis old data become less effective. In technical
analysis an uptrend is defined as a series of higher highs and higher lows
while a downtrend is a series of lower lows and lower highs.

This is a
common market pattern, you will often see price going in a direction, then
stalling or correcting and eventually continuing to trend in the original
direction. In technical analysis those moves are called impulses and
corrections. An impulse is when the price moves decisively in one direction,
while a correction is when the price retraces. So, going back to our example of
using swings as support and resistance you can see in the chart below how the
price just flows in one direction with pullbacks along the way.

Remember
that technical analysis should be used as a risk management tool. If you use it
as your sole reason to take positions in the market, you will have a hard time
in the long run. Once you have your fundamental view, you can structure your
trade with technical analysis if that’s what you need and use the levels to
limit your risk and get out of the trade if it’s not behaving as you expected.

This article
was written by Giuseppe Dellamotta.