When trading forex or any other assets, fundamentals are the most important metrics to keep an eye on. In the currency markets, this includes things like inflation and employment data. However, as every experienced trader knows, fundamentals are not enough. It would help if you had a good understanding of technical indicators to know when to enter and exit the market.
Without a good knowledge of different technical analysis trading tools, you will either get in too late or watch as your profits disappear long after the opportunity is gone. The best tools you can use to increase your odds of winning are support and resistance levels. With the right application, support and resistance trading can increase the odds of profitability in forex trading.
What are support and resistance levels?
Support and resistance are indicators that show you levels where the price could turn, and a new trend likely to form.
In a scenario where the market is bearish, it gets to a point where buyers get the impression that the price cannot go down any further. This can be due to a change in fundamentals or the downtrend lowering the price so much that traders feel the risk of a further drop is diminished. Short sellers also get to a point where they feel that they have made enough profits and start folding up. At this price level, the downtrend starts to show weakness, and a potential reversal looks imminent. This price level is known as support, and if enough buyers enter the market, the price usually reverses, and a new bull trend forms.
A resistance level is the opposite of support. It is the price level where a bull trend starts to weaken or even shows signs of ending. It usually signifies that short sellers are entering the market. Resistance levels are usually triggered by a change in fundamentals or a price rising so high that short sellers believe an asset is getting overpriced, while early bulls start booking their profits. This leads to the bull trend slowing down or a complete reversal of the price in a scenario where short-sellers outnumber bulls.
Why it is important to understand support and resistance
Firstly, support and resistance levels help traders know when to get into a trade. At any given time, prices are either going up, down or trading sideways. Without support and resistance, it would be difficult to know when to buy in a bull trend, sell in a downtrend, or wait for a consolidation to come to an end. Essentially, it helps in making more precise trades, which is fundamental to winning in the markets.
Support and resistance also help a trader know when to exit after opening a trade. Without support and resistance, one can easily exit the market too early and miss out on gains or stay on too late that the gains made are wiped out.
How to successfully trade support and resistance
To successfully trade support and resistance, it is best to wait until the price has cleared off these levels. For instance, if the price is trading at a resistance level, the best time to go short is after bearish volumes have risen and the price has cleared off the resistance. On the flip side, the best time to buy is when buying volumes rise, and the price clears off a support level after a downtrend.
Support and resistance levels are among the best tools for making precise entries and exits into forex trades. However, while they are helpful, support and resistance levels only work when applied correctly. The best way to trade is to only enter or exit the market when the price clears the support or resistance with high volumes.