After learning about trends, the next major concept you need to learn is that of support and resistance. You'll often hear analysts talking about a certain security approaching a resistance or support. These are simply price levels or a range of prices that a security or currency doesn't often go over (resistance) or go under (support).

Figure 1 – CAD/AUD

 

Figure 1 depicts a simple example of a resistance level and support level on the weekly chart of the CAD/AUD pair. You can see in the chart the support is the level at which the price seldom falls below and the resistance is the level the price seldom exceeds. Each time the price hits the resistance or support, the price appears to hit a wall and reverses, at least in the short term.

 

Why Does it Happen? 

The primary reasons why prices behave in this fashion is because of supply and demand and market psychology. At support levels the number of buyers generally exceeds the number of sellers and pushes the price back up, and at resistance levels the number of sellers exceeds the number of buyers causing the price to go back down. This could occur frequently in a range until new material information is available that shifts the price to a new range, in which case a new support and resistance level would be established.

 

Role Reversal 

Once a resistance or support level is breached, the roles of the resistance and support flip. If the price surges below a support level, that same support level will then become the new resistance level. Conversely, if the price surges above a resistance level, that same resistance will tend to become the new support level. This role reversal will generally only occur once a strong price moved has shifted the price to a new range - often caused by major news or economic reports. As an example take a look at Figure 2. Initially, the dotted line represented a resistance level, but once the price broke through the resistance into a new range, the old resistance level became the new support level. Again, once the price broke below the dotted trendline the level reverted to acting as a level of resistance. (For more, see: Support and Resistance Reversals)

 

 

Figure 2 – AUD/USD

 

Resistance and Support Levels 

Sometimes with stocks, a support or resistance level will be a round number such as 50, 100, or 1,000 that represents a psychological barrier to further increases or decreases in the price. But in forex as well as stocks, keep in mind that a support or resistance level can vary, and is often not an exact number. In the case of the AUD/USD pair shown in the Figure 2, it appears as though 0.95 is a level that has historically acted as a level of support and resistance. It is strategic for traders to view support and resistance levels as zones rather than a specific number. (Learn the difference between a reversal and retracement in Retracement Or Reversal: Know The Difference.)

The Importance of Support and Resistance 
Support and resistance analysis is an important part of trends because it can be used to help make trading decisions and identify when a trend may be reversing. These levels can sometimes help a trader identify when to take profits. For example if a certain price levels is reached, the trader might want to take profits because he knows the price level seldom rises past a particular resistance level. Or alternatively if the trader identifies a support level the price seldom falls below, he could use that information to help him decide on an entry point to his position. (To learn more about using resistance and support levels in trading, refer to our article Trading on Support.)

Support and resistance levels are tools every trader that uses technical analysis should use and monitor. In the next section, we'll take a look at another common chart pattern that can help you identify upcoming price movement - the double top and double bottom.

 

Double Tops And Double Bottoms

Related Articles
  1. Investing

    The Psychology Of Support And Resistance Zones

    Emotion drives the market more than you might realize. Find out how psychology affects support and resistance zones.
  2. Trading

    Support And Resistance Basics

    Understanding the concept of Support and Resistance in trading can drastically improve your short-term investing strategy.
  3. Trading

    Trade On Support For The Best Exit Strategy

    Find your sound exit strategy based on support and resistance levels, while understanding the psychology behind them.
  4. Trading

    Four Stocks For Range Traders

    These four stocks are locked in ranges, offering low risk and high reward opportunities if the ranges continue.
  5. Trading

    Twitter Stock Breaks Out Toward Resistance Levels

    Twitter shares jumped amid rumors and call option buying, but traders should watch for a breakout from these key levels.
  6. Trading

    Intel Rebounds from Support Levels

    Intel's rebound from the 50-day moving average could set the stage for a run to resistance levels at $38.29 per share.
  7. Trading

    Pivot Strategies: a Handy Tool for Forex Traders

    Make more educated trading decisions by identifying major turning points.
  8. Trading

    Moving Average Explosions

    Find out how you can profit from this short squeeze strategy.
  9. Trading

    Strong Stocks with More Bullish Potential

    These stock are trending, and setting up to go even higher. Here's how to trade them.
Frequently Asked Questions
  1. Why is the 1982 AT&T breakup considered one of the most successful spinoffs in history?

    Find out why the breakup of AT&T into a number of spinoffs called the Baby Bells was one of the most successful spinoffs ...
  2. How does the required rate of return affect the price of a stock, in terms of the Gordon growth model?

    Find out how a change in the required rate of return adjusts the price an investor is willing to pay for a stock. Learn about ...
  3. What is the difference between the cost of capital and required return?

    Take a look at the primary conceptual differences between an investor's required rate of return and an issuing company's ...
  4. What's the difference between the production cost and the manufacturing cost?

    Learn more about fixed and variable expenses incurred by businesses. Find out how production and manufacturing costs impact ...
Trading Center