FOREX FOCUS
Access to foreign exchange trading has opened up exciting trading options for the retail trader. You can now trade alongside corporations and institutions in a highly liquid market that is global, traded around the clock, and highly leveraged. Before jumping into this market, however, we must understand the factors that affect the forex market. With that in mind, STOCKS& COMMODITIES has introduced Forex Focus to better prepare the retail trader to participate in the currency market.
Support & Resistance Precision In ForexCurrency markets tend to follow support & resistance levels. Use those levels to identify entries and exits, and to apply risk management.
by James Chen
Many foreign exchange traders rely on the accuracy of support & resistance levels so evident on currency price charts. Some of these traders will eschew the use of mathematically derived indicators or back-tested systems as primary trade decision tools, preferring instead to allow their manually drawn lines to dictate entries and exits.
BACK TO BASICS
There is much to be said for this back-to-the-basics brand of technical analysis. Even a glance at a long-term currency chart will substantiate that key price levels appear to be remarkably well-respected time and again. This applies to both diagonally drawn uptrend and downtrend lines, as well as to horizontal support & resistance lines.
Central to these principles of support/resistance (S/R) within the greater context of technical analysis is the premise that a truly valid S/R level will eventually be tested on both sides; support will become resistance and resistance will become support. A line that is tested on both sides often proves to be strong and stable and will frequently sustain its validity for an extended period of time, as support or as resistance.
Of course, in order for a resistance line to become a support line there needs to be a breakout of the original resistance line, and conversely, for a support line to become a resistance line there needs to be a breakdown of the original support line. An S/R level would, by necessity, have to be breached before that same line could be established as a continuing S/R level on the opposite side. The irony lies in the fact that one side of the S/R needs to be invalidated in order to create the framework for the other side of the S/R. But this can create a variety of possible trading opportunities.
Practically speaking, trading off support or resistance, whether it is in an uptrend, a downtrend, or a horizontal level, comprises two chief options. One option is to assume that the price level will be respected, and consequently trade bounces off the line. The other option is to assume that the level will be breached and consequently trade breakouts of the line. These two trading strategies are diametrically opposed in both trade direction and philosophy. Most often, a technical trader will allow actual price action at or near the critical S/R level to determine which of the two paths, if any, to take.
Whichever path you choose, keep in mind that support & resistance has never claimed to be an exact science. At the same time, however, the charts presented in this article will demonstrate that at least in the realm of forex, it comes surprisingly close.
Return to August 2007 ContentsOriginally published in the August 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.