Technical analysis teaches us how to read the language of the markets as we trade Forex online. After we learn how to read it, we may begin to speak it as well, interacting with fellow traders in the vast Forex universe, and profiting from our knowledge. Technical analysis’ tools of translation are the indicators, and price formations that are drawn on price charts. While many of these tools have their critics and supporters, support and resistance lines have been upheld by a majority of analysts over the years due to their tendency to correspond with strong fundamental factors that sustain them over their period of existence.
Let's take a price chart, and take a cursory look at it. You will notice that there are many price levels at different timeframes where the price rebounds many times throughout the day. All these various levels are potential support or resistance levels. A line drawn on the chart with a number of tops is called a resistance line, while a price line where numerous bottoms are located is termed a resistance level.
It is important to understand that there are different kinds of support and resistance levels. Some are purely technical. They are created because a large number of trader orders are clustered at a particular price level, making it hard for the buyers or sellers (depending on the trend) to breach through that level. Sometimes these orders exist from a long time ago. At other times, they were created recently. But they are numerous enough to stop the trend’s momentum a couple of times.
In other cases, support or resistance lines are created by officials or major financial institutions that have a stated interest in maintaining a particular level. This may be the case with Japanese exporters who would like to hedge at a price, or a central bank intervening to discourage speculators, as well as many other factors. This second type of support/resistance is in general much more reliable than the former.
In absence of secondary data, a support or resistance line that is dependent only on technical values is usually valuable in hindsight only. The line may have held five, six, or seven times, but at each reversal it may not have held and failed. For each support/resistance line that held, there were many that failed. It is important to bear this in mind whenever you trade these levels.
Support/resistance lines are traded best with technical indicators suited to range patterns. Once a level is established, it is easier to trade it with range indicators, because, depending on the strength of the trend, the rebounds and reversals from the resistance or support level will resemble a range pattern, even if it is not a genuine one. Thus, the best results are gained in Forex strategies that utilize the correct indicators and combine a favorable risk/reward profile to a strong analytical exercise establishing the validity of the trend.