Analyzing price charts using support and resistance lines is already a well-known concept for most forex traders. Although a bit more advanced, there is another related concept you should also make sure you can master before you venture into other trading strategies; trading with support and resistance zones.
You see, simple lines on a chart is often not enough. Since trading is not an exact science, it is sometimes necessary to approach it more like a form of art. It surely takes more experience to read a chart without specific rules to follow, but the payoff once you master this can be great.
We will start by defining what the terms really mean:
- Resistance zone: An area on the chart where there are more sellers than buyers.
- Support zone: An area on the chart where there are more buyers than sellers.
The reason why these zones or levels work is that the market has inherent “memory” about past price action. In other words, traders and robots around the world remember at what prices they bought a certain currency pair, and will then determine whether that currency is “cheap” or “expensive” based on their past experience.
In addition to that, price levels are also often formed by large institutional traders who have client orders to buy or sell an asset at a specific price, often around round numbers.
For example, a broker may have been instructed by a large client to sell AUD/USD at 0.80. As such, every time the price of AUD/USD hits 0.80, the broker will send his sell order to the market and hence push down the price again.
Obviously the forex market is huge, and an individual trader cannot make that much of an impact, but if there are enough brokers that send their orders to the market at the same prices, a technical price level is formed.
It is also important to understand that these levels often occur around the same area in the chart as other technical levels, such as Fibonacci extensions or retracements.
When two or more factors align to indicate a certain bias in the market, we say that it is adding confluence to our bias. Confluence of two or more technical indicators are considered one of the best buy or sell signals you can get.
If you also have added confluence by the price trading at or near a support or resistance zone, the signal is considered to be very reliable.
It may be difficult for new traders to get used to thinking in terms of areas on the chart rather than lines or levels, but it is definitely worth the effort.
As an example, let’s take a look at the chart below.
In this chart of palladium / US dollar, a resistance line has been drawn from a past market top. Notice, however, that as the price approaches the resistance line again, it doesn’t stop and instead continues to trade higher, confusing all the traders who have already placed their short orders in anticipation of the decline.
This is obviously the amateur approach to forex trading. Professionals know that trading is never exact, and they instead stick to support and resistance zones, rather than lines. By doing this, they can catch the bulk of the price action and ride the trend.
If you do like the professionals and wait for the price to trade outside of the resistance zone, your odds for success will be significantly improved. One approach is to wait for the price to cross below for example the 20 simple moving average line before you enter your short order.
That way, you bias has been confirmed by the market before you take any premature action, and you are reacting to what is happening instead of predicting the next move.
As you can see in the chart above, it is much easier to draw support and resistance zones than lines, because the highs and lows don’t need to match up exactly. You can also easily see the sharp change in direction as the price enters into the resistance zone.
If you have a long position as the price is entering into a resistance zone like this, you should tighten your stop-loss orders and closely follow the price action. The price may shoot through and make another high, but it may also change sharply and trade in the opposite direction.
As already mentioned, it may be a bit difficult for beginners to get used to thinking in terms of zones rather than lines. It is simply a more discretionary approach, and there is no exact recipe to follow.
Many traders would therefore benefit from taking a forex course. With experience and the right education, it gets much easier, and the payoff can be great.
Aim for the middle part of the trend, and stop trying to call tops and bottoms. It is simply too difficult to be worth your effort.
About the author
Fredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He mainly follows the stock and forex markets, and is always looking for the next great alternative investment opportunity.