Support Becomes Resistance And Resistance Becomes Support
Have you ever heard traders talking about “support levels becoming resistance” or “resistance becoming support“. This post will look at the significance of S&R in addition to demonstrating why Forex traders really should pay attention as the support/resistance dynamic shifts. Past price action does not predict what will subsequently happen on a chart with absolute accuracy but it can help us in defining our approach.
Anyone familiar with support and resistance can skim this section and go to the chart example below.
We will first of all look at a simple scenario where Forex pair X/Y has tried to drop under a horizontal support level repeatedly during the last few days, however even though the price draws near to this level on numerous occasions it just can’t get underneath it and there are multiple inflections. In this instance, the horizontal support level is referred to as such since it is a specific area where the majority of traders are purchasing Forex pair X/Y, stopping the forex market participants from pushing rates lower.
Basic Horizontal Support Level
One of the most fascinating things relating to support and resistance takes place when the movement of the Forex pair is eventually allowed to break over or under (under in this instance) the observed S&R area and find an intrinsic value. At these times, it isn’t unusual to discover an earlier area of support altered its characteristic and turned into a clear area of resistance. Traders use the term resistance to describe when the price of an asset has difficulty moving above a given price level, which then forces the price of the asset to decline.
Support Now Resistance
Let’s now look at a recent chart example. The AUD/USD currency pair had major difficulty breaking through 0.9400 to the upside. The first boxed area shows how price could not make a new high. Price did in fact actually actually move lower after the third attempt on this weekly chart. When price did finally make it through the level it did not have the bearish momentum to come back and hit the level until the second yellow box. See how the bulls took AUD/USD higher after this retest! There are no guarantees of this happening of course but it does happen on all different timeframes on a regular basis if the level is significant. There are a multitude of reasons why this can happen including barrier option dynamics and similar; it is also not unusual to see this happen near to large whole numbers as was the case in this instance with the 0.9400 handle.
So, “Why does resistance become support like this?” you may ask.
It’s fair to assume that the market was selling heavily at 0.9400 during yellow box 1 isn’t it?
So what happens to all of these sellers when the market moves through their sell area and moves higher?
They are in serious draw down on any positions they hold! How do you feel when you are in a trade which turns into a big loser and suddenly you are back at breakeven on the deal?
Happy to get out of the trade maybe? There you have it… resistance turns into support. There is of course more to it than this. The self fulfilling prophecy element comes into play as technical traders are well aware of this phenomenon. The most important point is that this does happen and as traders we need to seek out ways of using this information to our best advantage.
An interesting example of a resistance to support flip can be seen on the following chart, which shows the GBPUSD pair around the recent UK PMI data release.
Price was finding resistance through the London trading session and managed to break strongly to a new high when the data came in better than forecast. Anybody trying to catch the initial spike would have likely experienced high slippage with their forex broker; however, the patient technical trader has an opportunity to go long when price once again hit the resistance level around an hour later.
This trader would be going long knowing that the near term market sentiment was favouring the pound following the PMI release. Price will not always act this way of course, but in this instance there was a technical setup aligned with a positive data release.
We will now look another practical application of the above. The word advanced is possibly not the best description because everything actually boils down to the basics explained above. However, there are a few ways of approaching support and resistance which require a slightly different approach.
We will start of looking at a Bearish Engulfing candle on the following chart:
See how the first resistance area (box 1) turns into support (box 2) when hit. Price has come down to the level with serious bearish momentum, actually forming a bearish outside candle in the process. Price has dropped from around 1.3299 to 1.3000 – about 300 pips – and sellers are not keen to sell at these levels as market movements rarely progress in a linear fashion. Strong levels like this quite often take more than one attempt to break through even when the market has a strong directional bias.
At this stage (with the information provided above) we have a belief that the market is bearish, in the near term, and now have a bearish reversal signal near the swing high.
Where to sell and try to profit from this belief though?
As these are higher timeframe candles there is a good chance that each candle high and low is watched carefully by technical traders and has associated “order flow”.
Let’s take the last five candles and look closer. See the new pink line (on the small chart to the left) and how this was the 3-week low before our current bearish candle. This gives a potential resistance entry area for a short trade in our favoured direction when considering the bearish outside/engulfing candle. There is often a retest on previous weekly/daily highs and lows as the market looks to be attracted to areas where orders are clustered.
See the final chart below – support has now become resistance and the bearish outside candle was played with virtually no drawdown. Of course this will not happen every time but there was a carefully calculated entry combined with a reasonable expectation that the low of the bearish candle would be taken out if our initial entry area worked as resistance.
You can try this for yourself by opening a demo account and working on your support and resistance plays. Support and resistance is only half of the story and it is equally as important to look at how price is approaching these levels. Ideally price will be overbought or oversold as it hits the area. Things like the daily range or ATR can help here. Take a look at this support and resistance chart example of how price can hit a level after covering a lot of distance in a small amount of time.