Types of Technical Analysis Tools
After having done with the three types of Forex trading analysis, we shall now delve into the next topic about the basic technical analysis tools such as support and resistance levels, candlestick formations, and common chart patterns. You can try out the leading and lagging indicators and learn how to apply them on your practice trade platform.
What are Support and Resistance?
Support is the price level where a certain security or currency does not cross above, it stops and pulls back. Resistance is the price level where a certain security or currency does not cross below, it stops and pulls back.
Figure 1 above shows an example of a support and resistance level. In the chart, you can see the support level at which the price seldom cross below the bottom red line and the resistance level at which the price seldom cross above the top red line. Each time the price touches both the support and resistance levels, it pulls back.
The reasons why prices move in this manner is due to the supply and demand and market psychology. At the support levels the buyers usually outnumbered the sellers thus pushing the price back up, and at the resistance levels the sellers outnumbered the buyers causing the price to drop back. This could happen periodically in a range until fresh physical news is available that would moves the price to a new range, in which case a new support and resistance level would be formed.
Once either level is breached, the positions of the support and resistance reverse. If the price slips below a support level, that particular support level will then represent the new resistance level. If the price slips above a resistance level, that particular resistance level will tend to represent the new support level. This change of position will only happen when a strong price moved has altered the price to a new range – usually caused by economic reports or major news.
Figure 2 above clearly shows how the support level turns into the resistance level which then finally turns back into the support level after the price unsuccessfully made three attempts to break through the resistance level.
Support and resistance analysis is a crucial part of trends as it can be used to assist a trader to:-
- spot when a trend might reverse
- decide when to enter a trade
- identify when to take profits
- make other trading decisions
For example, if the currency price reaches a certain level, the trader might decide to take profits as he is aware that the price level seldom surges past a particular resistance level. On the other hand, if the trader spots a support level the price seldom falls below, he could use that knowledge to assist him decide on an entry point to his position.
You can now practice plotting the support and resistance levels but before you proceed you have to bear in mind that both support and resistance can vary and are not an exact number. You should consider them as a level or zone rather than a fixed number.
One way to assist you to find these levels is to plot support and resistance on a line chart. You can refer to the above two charts for reference. Looking at the line chart, you can plot your support and resistance lines around the areas where the price is forming several peaks and valleys.
Support and resistance are tools that should be used and monitored by every trader who uses technical analysis to trade. With practice, you will be capable of identifying potential support and resistance level easily.
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