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 Forex
Currency 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 Contents
Originally published in the August 2007 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
