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Understanding support and resistance in FX trading

Mastering support and resistance in FX trading

If you’ve started trading FX or are contemplating giving it a go, you may have heard of support and resistance. What is support and resistance in FX trading and how do you master it to use it for your trading strategy? This article is an introductory article explaining some of the most common terms and strategies used in Forex trading.

What is support and resistance in trading?

Support and resistance levels are used to refer to the ceiling or high price (resistance) and floor or low price (support) of a certain asset price, commodity, or currency pairing. They are often visualized as horizontal lines on trading charts.

If you start reading about support and resistance you are likely to hear pivot points mentioned as well. Pivot points indicate a price range to traders where prices are likely to change or turn. It’s important to remember that when talking about support, resistance, and pivot points, traders are always implying price ranges and never fixed price points. There are always chances of breakouts either way, although less common in FX currency pairings which tend to be more stable depending on the currency pairing and time frame you are looking at. There’s also a big difference between major and minor support and resistance which we’ll also explain a bit further down in this article.

S1, S2, S3, R1, R2, R2 – what is that all about?

No, FX traders are not in the business of inventing new chemicals. All those Ss and Rs are called classical pivot points. To understand pivot and S/R calculations you need to first be familiar with the highest (H), lowest (B) and closing (C) pricing points of the previous trading day. Those previous-day pricing points are used to calculate the classical pivot and 3 support and resistance levels. Usually, your trading software will be calculating those for you.

Here are the formulas which should help to demystify all the Ss and Rs which are called classical Pivot Points:

H = highest price previous trading day
B = lowest price previous trading day
C = closing price previous trading day

Pivot = (H + B + C) / 3
S1 = (2 x Pivot) – H
S2 = Pivot – (H - B)
S3 = B – 2x (H – Pivot)

R1 = (2 x Pivot) – B
R2 = Pivot + (H - B)
R3 = H + 2x (Pivot – B)

So, the next time you read an FX headline that reads ‘EUR/USD breaks above 1.20 as US Dollars losses intensify’ you will understand that the EUR has recently exceeded its previous major resistance level of 1.20. This could suggest that the EUR is on an upwards trend in comparison to the US Dollar and could suggest a new EUR upwards trend, something to monitor and keep an eye on as a trader. At the same time, it could also mean that the EUR has hit or is about to hit its ceiling which could result in a big sell-off of EUR in the near short-term.

What is the difference between major and minor support or resistance?

We’ve mentioned major and minor support and resistance levels a few times. What is the difference and why does it matter? Major and minor support and resistance levels are especially important if you’re day trading. As with any trading strategy understanding your timeframe (the period that you use to analyze a particular asset, commodity or currency) and your exit strategy.

In short, major support and resistance levels are the lowest and highest price points that have been in place for a certain time (think medium to long term). Whilst there might be short-term breakthrough pricing, or piercing, the currency is much less likely to break through a major support and resistance point for a very long time, and generally speaking, you can expect many traders to either buy or sell at those points. Unless an entirely new zone of new support and resistance levels has formed.  

How to use support and resistance in your trading strategy

Most traders are looking for support levels as signals to buy a currency on the cheap and resistance levels to sell for a profit. The reverse is true if you’re in the business of short selling.

What point is right for you heavily depends on your timeframe for trading and your reason for trading currencies in the first place. Some traders focus on major support and resistance levels whilst day traders may focus on minor support and resistant levels when every pip starts to count. Many traders wait for some consolidation in that space before buying or selling.

Another strategy is to look out for false breakouts which are short-term breakthroughs on either resistance or support levels that don’t tend to last for long.

Whatever your FX trading strategy, always make sure you have a clear exit strategy in place, i.e. be clear what your target price is to make a profit.

Take your understanding further

Many factors influence a currency pair movement, such as trade agreement announcements (link to article), central bank decisions (link to article) and many other factors. Make sure to check out our weekly insight piece on FX trading (link to the page with insights). Happy FX trading!