Understanding technical analysis gives you the edge as a forex trader. It develops your confidence in your analysis of what will happen in the markets in the future.
However, the greatest drawback with most of the technical indicators is that they lag behind the markets. This means part of the price action has already taken place before the movement is reflected by the technical indicator.
However, support and resistance levels especially those calculated based on Fibonacci levels are considered to be leading indicators of the price action. They lead the markets in predictable paths. Now, when we are saying predictable, it does not mean 100% guaranteed, but these levels can be pretty close.
Support is the price level that a currency pair touches but has trouble breaking through to the downside. Support is also called the floor of the currency pair price movement.
Resistance is the price level that a currency pair touches but cannot break through to the upside. Resistance level is also sometimes called the ceiling of the currency pair price movement.
Many new traders are surprised at the strangely predictable and reliable price action that takes place at the support and resistance levels. Most of the time, they will find the price action oscillating between the two levels in a market.
Why it is that majority of the people begin buying and selling at the given support and resistance levels. There is nothing on the charts that forces the people to do so.
A simple explanation is this that majority of the forex traders think the support level as the best price available to them and considers it an excellent opportunity to buy once it reaches the support level.
Similarly, at resistance, majority of the forex traders think that currency pair is not favorably priced and has become overpriced. So they consider it as an excellent opportunity to sell the currency pair.
You will have an excellent advantage in your trading if you are capable of accurately identifying the support and resistance levels in the markets. As more and more people start using technical analysis and calculate the support and resistance level, the more these levels become self fulfilling.
One important requirement of support and resistance levels is that price level is reached a number of times but never breached. Support and resistance levels can be horizontal like that for a ranging markets or they can be sloping up or down like that in a trending market.
Now, what happens at the support level is that as traders begin to sell the currency pair and take profit, the price of the currency pair drops down. As the price starts to fall, other traders who are interested in buying the currency pair keep on watching how far it will go down.
Most of them have done their calculations as to how far the price will fall down before they place a buy order. Past price action has convinced them the price offered at the support level is the best. So when it reaches that level, most of them jump into action and start buying.
When there are more buyers than sellers in the market, the market becomes bullish and the price of the currency pair starts to rebound and rise. It rises till the resistance level when majority decide that the currency pair is now over priced and start selling and go short.
This oscillating price action keeps on repeating itself and the support and resistance levels are seldom breached until and unless there is a fundamental change in the markets that forces new levels and a new direction.
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