The trading methodologies in this book are built on the assumption that
you will build your skills as a support and resistance trader. Identifying
support and resistance isn’t difficult with a little practice. This section will
teach you the techniques I use to identify support and resistance. By the
end of this section you will be able to identify support and resistance levels
on any currency pair and any chart timeframe. You will learn to identify
key support and resistance levels that offer a higher probability of success.
You’ll learn how to identify a good deal using a technique I call the bargain
day, which is a major component in every trading methodology this book
teaches. Finally, you will learn how to time your trades to take advantage
of the market’s natural rhythm within a 24-hour trading day.
Using Trend Lines
Trend lines are diagonal lines used to visually depict the direction of price
on a chart. Traders often use trend lines to enter trades whenever the market
touches them or breaks through them. I prefer to use trend lines as
a guide to determine trends due to their subjective nature. Traders draw
trend lines many different ways, making questionable their usefulness to
support and resistance trading. Just because you draw a trend line on a
chart doesn’t meant there is evidence through support and resistance that
price will respect your trend line. Trend lines are useful as a guide to determine
whether you should consider buying or selling a currency pair based
on trends.
The generally accepted practice to draw trend lines is by connecting
three or more consecutive price points without the trend line being broken
by price. In an uptrend, the trend line should connect consecutive lows that
are increasing in price. In a downtrend, the trend line should connect consecutive
highs that are decreasing in price. Figure 3.7 illustrates trend lines
in use during a downtrend and an uptrend. Notice how the EUR/USD downtrend
slows and consolidates prior to breaking through the downtrend line
and establishing a new uptrend.
Using Horizontal Lines
Horizontal support and resistance are drawn using lines that connect consecutive
highs or consecutive lows. Horizontal support and resistance lines
represent a distinct boundary in the battle between buyers and sellers because
supply and demand temporarily balanced and price was unable to
continue through them. These support and resistance areas are the primary
technique used to enter trades and manage risk by every trading methodology
in this book.
Drawing Support Support is drawn across consecutive lows, indicating
a price area where buyers have balanced sellers and price was unable
to move lower. It is important to understand recent price action before you
consider buying a currency pair along support. During an uptrend, support
acts as a jumping-off point for demand to push prices higher, making it a
good area to consider buying. You do not want to buy into support during
a downtrend, because the market is likely to break through support to
achieve new lows. Figure 3.8 demonstrates how to draw support during an
uptrend.
Drawing Resistance Resistance is drawn across consecutive highs,
indicating a price area where sellers have balanced with buyers and price
was unable to move higher. During a downtrend, resistance offers traders
a low-risk, high-probability area to sell a currency pair and join the existing
downtrend. Knowledge of recent price action or trends is important to correctly
selecting resistance. It is not advisable to sell at resistance during an
uptrend, because the market is likely to push through resistance and make
a higher high. Figure 3.9 demonstrates drawing resistance levels during a
downtrend.
You might have noticed by now that support and resistance often
change roles. When support is broken, the market often tests it again as
resistance before the market falls further. Conversely, when resistance is
broken, it is often tested as support before the market moves higher. These
principles are important for support and resistance traders because they
offer high probability, low risk, and predictable areas on the chart to enter
trades. Figure 3.10 demonstrates this principle in action using a EUR/USD
four-hour chart. Earlier in the chart the EUR/USD broke out of consolidation
and fell several hundred pips. This breakout created a resistance zone,
as shown by the parallel lines in Figure 3.10. When the market revisited
the resistance zone, it sold off again. Support and resistance traders who
identified this resistance opportunity were able to capitalize on a fantastic
Using Key Zones
The challenge many traders face is determining which horizontal support
and resistance levels have the highest probability of holding price versus
which will fail. Although trend and price action have a lot of influence on
selecting the right support or resistance level, there are some shortcuts
you can use to quicken the process. Key support and resistance zones can
be used to increase the probability price will respect the price level and
offer you a good trade. Key zones are created by identifying psychological
round numbers, range extremes, strong rejections, and turnabouts. These
techniques offer the highest probability of success, in my opinion, and I use
them on a regular basis.
Using Round Numbers Using round numbers to identify support and
resistance is an excellent strategy because it takes advantage of the psychology
behind supply and demand. Traders are people, and people like to
think in terms of round numbers, allowing you to exploit this trait in the
forex market. Entry and stop orders are routinely clustered around round
numbers because it is easier to calculate the profit or loss mentally when
you’re considering a trade. For example, would you rather calculate profit
or loss on a trade placed at $1.20 or $1.19836? The more zeros a price has
in it, the stronger a barrier it tends to be.
Round numbers are particularly effective to use near the open of a major
trading session. When the market is hovering above or below a round
number ahead of the London or New York open, it is likely that the market
will test that round number as trading gets under way. The reason this
happens is grounded in supply and demand. If market makers are looking
to move price lower, they may move the market higher initially to generate
selling pressure by triggering stops above a nearby round number. The
opposite effect is seen when the market makers are looking to move price
higher. Traders often refer to this as stop gunning, and though most market
markers would never admit to doing it, you can see it play out on charts
time and time again.
Bargain hunters can use this market behavior to their advantage by
anticipating when it will happen and placing their orders to take advantage
of it. If the market is trading near a round number and you believe it may
be gunned at the open, place your orders 10 pips above or below the round
number. In my experience, when a round number holds after it is gunned,
the market rarely moves more than 30 pips higher than the round number
before continuing in the opposite direction. When this technique works, it
offers a high-probability entry with extremely low risk.
Figure 3.11 demonstrates this technique in action. During an uptrend
September 10, 2009, GBP/USD was trading just above the round-number
price of $1.6500 before the London open. Shortly after the open, GBP/USD
traded down to test the round number and reached a low of $1.6479 before
continuing to rally higher.
Using Daily Ranges The daily high and low of each trading day represents
a key support and resistance level. These are two areas where supply
and demand balanced momentarily and formed support and resistance. It
is not uncommon for the market to test a daily high or low during subsequent
trading days, which gives support and resistance traders another
high-probability, low-risk area to enter the market. Understanding the currency
price action is important to using a daily range successfully. Regardless
of the long-term trend, if the recent trading days were very bullish, you
might want to consider buying near the daily low. If the recent daily price
action is bearish, consider selling the daily high. The usefulness of a daily
GBP/JPY within the context of an uptrend represented by the long arrow.
The daily low from Friday, July 17, offered trend traders an opportunity to
join the trend with very little risk.
Using Weekly Ranges The high and low prices of a full trading week
offer key support and resistance levels for traders, just as daily ranges do.
Weekly ranges have greater longevity than daily ranges do and may be respected
by the market for several days, weeks, or even months. Identifying
the high or low on a weekly chart is simple but doesn’t offer much detail to
plan a support or resistance trade. Using a lower timeframe will give you
a clearer picture of support and resistance along the weekly range. Figure
3.13 illustrates an example of selling the GBP/JPY at the weekly high.
Using a four-hour chart to plan this trade, you can determine whether the
weekly high is holding as resistance before you sell the currency pair. The
long wicks on each four-hour candle illustrate strong selling pressure in
that area as price rallies higher, only to be sold back down again. These
candle wicks are strong clues that a resistance or support level will hold
and a trade opportunity exists. Traders who sold near $159.70 were offered
a low-risk, high-reward trading opportunity along the weekly high.
Long-Term Support and Resistance Traders using price action to
plan support and resistance trades should start with very long-term charts
and then move to lower timeframes. The longer the timeframe you are
looking at, the more likely it is that the support and resistance level will
be respected by price. I developed my working theory on this concept not
because there is something magic about longer timeframes; rather, more
traders are able to identify long-term support and resistance. This is one
scenario where the idea of a self-fulfilling prophecy in the market may actually
have some merit. Weekly and monthly charts do not change as frequently
as daily or hourly charts. The support and resistance levels on longterm
charts may be respected for many years before finally being broken.
These levels of support and resistance should be known to any support and
resistance trader looking for a bargain. They are traded as any other support
and resistance level would be traded using the tactics outlined in the
next section.
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