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Using Support And Resistance Levels To Help Assess Potential Price Movement
Education | 18 April 2013
By: Stuart McPhee
Articles (22) Profile

In technical analysis, a support level is a low point that a price literally ‘bounces off’, as if there is a physical barrier that prevents it from moving lower. When viewed as a line plotted on a chart, a support level appears to hold up or ‘support’ the price, as the name implies.

Similarly, resistance is a level that the price moves up towards but fails to break through. The more times a price tests one of these levels over a short period, the more significant that level is.

If you look at the daily chart of the British pound (GBP/USD) in Chart 1, you will see how the price traded down and appeared to bounce off the support level at 1.51 on several occasions.

Chart 1

Support and resistance levels (also referred to as significant levels) are the result of demand and supply. Support is a result of undersupply and excess demand at that price level; resistance is a result of oversupply and diminished demand at that price level.

The different lines in Chart 2 also show levels of support and resistance. Of most interest is the resistance level at 1.05 (notice the two occasions when the price touched this level and turned away), which is finally broken towards the end of the chart.

Chart 2

Support and resistance levels occur more often at round cent levels or at 0.5 cent levels, for example the resistance level at 1.5350 over the last week in Chart 1. This demonstrates the tendency people have to behave en masse – many seem to prefer round numbers and therefore congregate there. Often there is no logical or rational reasoning for these round number prices, other than reflecting the way people think and behave.

When a resistance level is broken, that level often becomes a level of support. This is obvious in Chart 1 at 1.5250, which was a strong resistance level in the middle of the chart then became a level of support later in the period. The reverse is also common – if a support level is broken, it often becomes a level of resistance.

Many traders use levels of support and resistance to bolster their confidence in entering trades on the belief that these levels will continue to hold up and not be broken. Significant levels can also assist in placing stop loss orders, as a stop placed on the other side of a significant level can provide a degree of protection.

Get a free OANDA demo account to experiment with setting stop losses around significant levels for risk management.

Stuart has more than 16 years of trading experience under his belt and specialises in technical market analysis of major currency pairs. Apart from being the author of several bestselling trading books, with his most recently released book "Trading in a Nutshell", Stuart contributes to daily newletters and blogs. He also produces articles and videos on the how tos of technical tradings. For more information of Stuart, you can follow him on twitter @stuartmcphee or check him out on Google+.

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