There is a lot of material written about Forex trading, both high quality articles and lower-quality pieces. Unfortunately, much of the worst of it is written about support and resistance levels. It is an extremely important topic for Forex traders, yet the quality of widely available research and advice in this field is generally extremely poor. I’m going to try to think outside the box and ask some difficult questions, after explaining why support and resistance levels are so very important in Forex trading.
The Importance of Support and Resistance
All of trading can be boiled down to a quest to answer, at most, two questions: in which direction is the price most likely to move substantially, and at what price is it likely to turn in that direction after a movement in the opposite direction. Answering only one of these questions successfully is usually enough to trade profitably. Answering both correctly is sufficient to do very well. The levels at which the possibility of turns is relatively high are known as “support and resistance”. In Forex trading support and resistance have an especially high importance, because Forex tends to move with less direction and range more than most commonly traded stock indices and commodities. These are the reasons why Forex traders tend to be obsessed with trying to correctly guess these levels before the price reaches them: they provide opportunities for low risk, high reward trade entries.
Determining Support and Resistance Levels
As the importance of these levels is widely regarded as the key to profitable Forex trading, several claims are made as to how best identify them. One common claim is that round/whole numbers, “key” moving averages, pivot points and other derivative indicators tend to act as effective support and resistance levels. There is no evidence for this! I have never seen a single statistically valid Forex back test showing that these factors can stand alone.
Sometimes a similar but weaker claim is made: that when such levels are confluent with more intelligently identified support and resistance levels, the levels are strengthened and made more valid. Again, I do not see any evidence for this. I took a profitable back test of a trend following strategy conducted over thousands of trade samples spanning more than a decade, that bought on reversals from rejections of lows at the previous X bars, and filtered the results by whole / round numbers. The positive expectancy per trade was unchanged.
The result is that I do not believe there is any derivative indicator that can provide a trading edge by identifying support and resistance levels. But what about direct price levels? Some traders swear by daily, weekly, or monthly high and low prices, sometimes also opening prices of various sessions. I do not see any evidence that such price levels
provide any kind of systematic, mechanical edge. They certainly will sometimes, and I think there are two reasons why sometimes such levels will be effective and other times they won’t. Firstly, daily or weekly high or low prices which show sharper, faster hits and rejections tend to be more effective than when the constituent price action is different. Secondly, much depends upon the broader context of what the price is doing. If the price is in a strong upwards trend, previous daily or weekly high prices are unlikely to be very effective resistance levels. On the other hand, in a strong upwards trend, the price is unlikely to hit such support levels very often either. The bottom line on identifying support and resistance levels: do not expect to get an edge from any formula. You must know how to read a chart intelligently, and consider the prevailing conditions at the time the level is hit. For example, say 1.1000 looks good as probable resistance, as the price topped there a few days back and has continued to fail to make new highs. Then news is released that a relevant central bank has changed its interest rate and the price is driven up to 1.1000, but this level is unlikely to mean much in the new market condition.
Prime Conditions for Support and Resistance Levels
The best market condition in which to use support and resistance levels as a major basis for trading decisions is an absence of trend, i.e. ranging conditions. Many traders tend to make the understandable mistake of looking for support levels in an uptrend and resistance levels in a downtrend. There is nothing wrong with that, but you don’t want to be sitting out a strong trend without taking any trades just because the pull backs never reach your targeted levels!
Do Support and Resistance Levels Really Matter Anyway?
I mentioned previously that by following trends, it is perfectly possible to make money without ever thinking about support and resistance levels. If you have ever wanted to take a trade, but felt that you were trading into a support or resistance levels, only to watch the price later shooting past the level without you, then you will know what I am talking about.
Traders searching for a better way to approach Forex should consider whether they are relying too heavily upon support and resistance. Such an over-reliance can lead to too much counter-trend trading and missing out on good trades. Most of the best Forex trades available do not begin as reversals from well-defined support and resistance levels, and that’s something worth thinking about.