Forex Trading Strategies

Forex trading strategies are essential for a trader to know exactly when to sell or buy a currency pair. The time of purchase or sale of foreign currency pairs is the most important point of a trade. The better that the trader is able to determine the time of entry / exit, the more profitable is a potential transaction. This can be achieved with sound Forex trading strategies.

Forex trading strategies in combination with technical analysis is usually used, especially to determine the time of entry / exit. Most often, a decision is made within seconds or hours.

Main Forex trading strategies are:

1. Support and Resistance

Sound Forex trading strategies, similar to this one, remain profitable, even though they started to be used long ago. When Resistance is broken, it can serve as a good sign to buy. This new position can be secure with the aid of a stop-loss placed directly below the level of a break. The level of a break now will become a level of support. New positions can also be opened, when in a descending trend the prices rise up to the Resistance line. New positions can also be opened, when in an uptrend the prices fall down to the Support line.

2. Scanning for the intersection of trend-lines

If you are very confident in a particular trend line (i.e., if you checked it many times), the intersection of this line by prices would be a perfect time to enter into a trade or to get out of it sooner. And, of course, do not forget about the other technical indicators. In the case where the trend-line is used as Support and Resistance: buy, when prices reach an upward trend line; sell, when prices reach a downward trend-line. This can become one of your Forex trading strategies, based on the intersection of the trend-lines.

3. Trading in the break

Three Forex trading strategies for trade at the time of breaks:

- Open a position in advance, in the anticipation of a break;

- If you see an unfolding break, open your position at the time of its occurrence;

- Wait for the inevitable roll-back after the break, because in the market after a break, there is usually a correction.

There is also a 4th option for Forex trading strategies based on break – open position in each of the phases described above. One position – before a possible break, second position – immediately after this break and the third position should be traded in the hope of the expected price correction, which is likely to happen.

4. Trading with positions of various time frames

1). Forex trading strategies, based on long positions, i.e., ranging from several days to several months. It is best to use this tactic in the presence of strong trends. At the same time, analyze short-term scales. Be sure to use in addition to technical analysis also the fundamental analysis, which is perfectly suited for long timescales.

2). Holding a position of a medium length – a few days (the safest of the Forex trading strategies, based on time-frames). It is also desirable to ensure yourself by looking at shorter trends. Analysis of the medium length position is more complex, but such positions are much more stable for profit. Of course you need to choose the right moment to open / close a position. Again, these positions require the use of both – technical and fundamental analysis.

3). Holding a short position – minutes or hours (the least safe of all the Forex trading strategies, based on time-frames). The advantage of short positions is that they have virtually no risk on the impact of fundamental news, as well as the price will not change while you were absent because you’ll be watching the prices the whole time. The disadvantage is that the risk of loss is great, as well as you have to constantly monitor prices during trading until closing. To make the right decisions, it is best to be armed with data on the volume of sellers and buyers. This will allow you to much more precisely determine the subsequent direction of the market. Such ultra-short-term trading can also be used at the time of breaks as well as in the rollback of prices after the break. Basically, such positions are better suited for traders with extensive experience, while for beginners such positions hold too much risk. The second strategy (trading in medium-term trends, with duration of up to several days) is most suitable for the novice trader.

Forex trading strategies based on technical analysis indicators will help you achieve the best results. Forex trading strategies are especially useful for choosing the right time to enter and exit the trades.

Source: Steve Maenshel

Online Trading – MACD Divergence

Understanding how to interpret a MACD divergence can be very helpful for you in trading. Do you know what does a MACD Divergence means? Just that the current price trend is running out of steam. It soon may reverse direction. However, price reversal may not happen right away. But a MACD Divergence is a powerful hint. The market is changing direction. It is easy to spot MACD crossovers and dramatic rises. Not so a MACD divergence. Spotting a MACD divergence will only come after practice.

What you are looking for is when the price action and MACD do not agree. For example, if the price is making a series of higher highs and MACD is making a series of lower lows, something is wrong between the two.

Most probably the traders are getting nervous and slowly fading out of their trades. MACD divergence is seen as a sign that fewer and fewer traders are in the trend. No one is trading against the trend and yet fewer and fewer traders are in the trend.

The only traders in the trend are nervous. They are likely to exit their trade at the first sign of trouble. So if MACD is diverging from the bullish trend. As soon as the bears muster up enough guts to short, the bulls will exit and the bears will take over.

There are two powerful keys in locating times when MACD divergence is likely to represent a reversal in price. This is exactly why MACD is so powerful. It takes time to setup but when it works, it often works well.

MACD divergence can be powerful when the price is at the double tops or double bottoms. You are making your trading plan based on the bounce or breakout of the support and resistance. At this point you spot MACD divergence. This is known as Exhaustion Pullback.

You should trade now based on rejection reversal. This is a sign that the price action is running out of steam. This indicates that there are not enough committed traders to break the support and resistance (S&R).

MACD is also used as an overbought/ oversold indicator or oscillator. Suppose you see that it has reached its overbought/ oversold range. The price action is turning normal. This is a signal that you should avoid trading at this time.

Dont think that the currency pair is overbought and everyone is buying. However, when the price reaches its extreme, you will see price exhaust and the MACD line drop back into normal zone. Dont confuse the overbought/ oversold MACD zones as trade opportunities.

It is also important to note that divergence can not only be found on the MACD line and the signal line, it can also be found on the histogram. These two situations along with your other technical indicators can provide excellent trading opportunities.

MACD on eBridge Trader

Source: Ahmad Hassam

Measured Move – Bearish (Continuation)

The Measured Move is a three-part formation that begins as a reversal pattern and resumes as a continuation pattern. The Bearish Measured Move consists of a reversal decline, consolidation/retracement and continuation decline. Because the Bearish Measured Move cannot be confirmed until after the consolidation/retracement period, it is categorized as a continuation pattern. The pattern is usually long-term and forms over several months.

1. Prior Trend: For the first decline to qualify as a reversal, there must be evidence of a prior uptrend to reverse. Because the Bearish Measured Move can occur as part of a larger advance, the length and severity of the prior decline may vary from a few weeks to many months.
2. Reversal Decline: The first decline usually begins near the established highs of the previous advance and extends for a few weeks or many months. Sometimes this reversal pattern can mark the initial trend change, other times a new downtrend is established by new reaction lows or a break below support. Ideally, the decline is fairly orderly and lengthy with a series of declining peaks and troughs that may form a price channel. Less erratic declines are satisfactory, but run the risk of turning into a different pattern.
3. Consolidation/Retracement: After an extended decline, some sort of consolidation or retracement can be expected. As a retracement rally (or reaction rally), prices could recoup 33% to 67% of the previous decline. Generally speaking, the bigger the decline is, the bigger the reaction rally. Some retracement formations might include an upward sloping flag or rising wedge. If the formation turns out to be a consolidation, then a continuation pattern such as a rectangle or descending triangle could form.
4. Continuation Decline – Length: The distance from the high to the low of the first decline can be applied to the high of the consolidation/retracement to estimate the length of the next decline. Some technicians like to measure by points, others in percentage terms. If a security declines from 60 to 40 (20 points) and the consolidation/retracement rally returns to the security to 50, then 30 would be the target of the second decline (50 – 20 = 30). Using the percentage method, the decline from 60 to 40 would be -33% and projected decline from 50 would be 16.50. (50 X 33% = 16.50 : 50 – 16.5 = 33.50). Deciding which method to use will depend on the individual security and your analysis preferences.
5. Continuation Decline – Entry: If the consolidation/retracement forms a continuation pattern, then an appropriate second leg entry point can be identified using traditional technical analysis rules. However, if there is no readily identifiable pattern, then some other signal must be sought. In this case, much will depend on your trading preferences, objectives, risk tolerance and time horizon. One method might be to measure potential retracements (33%, 50% or 62%) and look for short-term reversal patterns. Another method might be to look for a break below the reaction low set by the first decline as confirmation of continuation. This method would make for a late entry, but the Measured (bear) Move pattern would be confirmed.
6. Volume: Volume should increase during the reversal decline, decrease at the end of the consolidation/retracement and increase again during the continuation decline. This is the ideal volume pattern, but volume confirmation for bearish patterns is not as important as for bullish patterns.

More than one pattern can exist within the context of a Bearish Measured Move. A double top could mark the first reversal and decline, a price channel could form during this decline, a descending triangle could mark the consolidation and another price channel could form during the continuation decline.

During multi-year bear markets (or bull markets), a series of Bearish Measured Moves can form. A bear move consisting of three down legs might include a reversal and decline for the first leg, a retracement, a decline for the second leg, a retracement and finally the third leg decline.

While the projection targets for the continuation decline can be helpful, they should only be used as rough guidelines. Securities can overshoot their targets, but also fall short and technical assessments should be ongoing.

As illustrated in the XIRCOM (XIRC) chart above, the second decline of a Bearish Measured Move may not be as orderly as the first, especially when volatile stocks are involved.

• Prior Trend: After a multi-year bull move, XIRC reached its all-time high at 69.69 on 31-Dec-99.
• Reversal Decline: The stock broke trend line support in Jan-00 and a lower low was recorded when the stock dropped below 45 in Feb-00. The decline took the stock to 29.13 in Apr-00 for a total of 40.56 points down.
• Consolidation/Correction: In April, May and June, the stock recouped about 50% of its previous decline with a retracement rally to 52.75. Including the spike high at 52.75, a parallel price channel formed (resembling a large flag) with support marked by the lower trend line. Excluding the spike high, the interpretation could have been a rising wedge. Either way, support was marked by the lower trend line.
• Continuation Decline – Length: The estimated length of the continuation decline was 40.56 points from the June high at 52.75, which would target 12.19. Percentage estimates can sometimes be more applicable to Measured (Bear) Moves, especially if the target appears unusually low. The decline from 69.69 to 29.13 was 58%. A 58% decline from 52.75 would mark a target around 22.16 (52.75 x .58 = 30.59 : 52.75 – 30.59 = 22.16).
• Continuation Decline – Entry: Because the consolidation/retracement portion formed a continuation pattern, entry could have been based on a break below the support trend line line (red arrows).
• Volume: Volume increased just prior to the trend line support break in Jan-00 and again when the stock broke below its previous reaction low (blue arrows). Later when the stock broke trend line support in July, volume also increased significantly (red arrows).

Source: Stock Charts

Measured Move – Bullish (Continuation)

The Measured Move is a three-part formation that begins as a reversal pattern and resumes as a continuation pattern. The Bullish Measured Move consists of a reversal advance, correction/consolidation and continuation advance. Because the Bullish Measured Move cannot be properly identified until after the correction/consolidation period, it is categorized as a continuation pattern. The pattern is usually long-term and forms over several months.

1. Prior Trend: For the first advance to qualify as a reversal, there must be evidence of a prior downtrend to reverse. Because the Bullish Measured Move can occur as part of a larger advance, the length and severity of the prior decline may vary from a few weeks to many months.
2. Reversal Advance: The first advance usually begins near the established lows of the previous decline and extends for a few weeks or many months. Sometimes a reversal pattern can mark the initial trend change. Other times the new uptrend is established by new reaction highs or a break above resistance. Ideally, the advance is fairly orderly and lengthy with a series of rising peaks and troughs that may form a price channel. Less erratic advances are satisfactory, but run the risk of forming a different pattern.
3. Consolidation/Correction: After an extended advance, some sort of consolidation or correction can be expected. As a consolidation, there could be a continuation pattern such as a rectangle or ascending triangle. As a correction, there could be 33% to 67% retracement of the previous advance and the possible patterns include a large downward-sloping flag or falling wedge. Generally speaking, the bigger the advance, the bigger the correction. A 100% advance may see a 62% correction and a 50% advance may see only a 33% correction.
4. Continuation Advance – Length: The distance from the low to the high of the first advance can be applied to the low of the consolidation/retracement to estimate a projected advance. Some technicians like to measure by points, others in percentage terms. If the first advance was from 30 to 50 (20 points) and the consolidation/correction was to 40, then 60 would be the target of the second advance (50 – 30 = 20 : 40 + 20 = 60). For those who prefer percentages: if the first advance was from 30 to 50 (66%) and the consolidation/correction was to 40, then 66.40 would be the target of the second advance (40 X 66% = 26.40 : 40 + 26.40 = 66.40). The decision of which method to use will depend on the individual security and your analysis style.
5. Continuation Advance – Entry: If the consolidation/correction is made up of a continuation pattern, then second leg entry points can be identified using the normal breakout rules. However, if there is no readily identifiable pattern, then some other continuation breakout signal must be sought. In this case, much will depend on your trading style, objectives, risk tolerance and time horizon. One method might be to measure potential retracements (33%, 50%, or 62%) and look for short-term reversal patterns for good reward-to-risk entry points. Another method might be to wait for a break above the reaction high set by the first advance as confirmation of continuation. This method would make for a late entry, but the pattern would be confirmed.
6. Volume: Volume should increase at the beginning of the reversal advance, decrease at the end of the consolidation/correction and increase again at the beginning of the continuation advance.

The Bullish Measured Move can be made up of a number of patterns. There could be a double bottom to start the reversal advance, a price channel during the reversal advance, an ascending triangle to mark the consolidation and another price channel to mark the continuation advance. During multi-year bull markets (or bear markets), a series of Bullish Measured Moves can form. While the projections for the continuation advance can be helpful for targets, they should only be used as rough guidelines. Securities can overshoot their targets, but also fall short – technical assessments should be ongoing.

Intel (INTC) broke out of a multi-year slump and began a Measured (Bull) Move.

• Prior Trend: After a large downward sloping trading range throughout most of 1997 and 1998, Intel broke above resistance in early November (blue arrows) and started the first leg of a Measured (Bull) Move.
• Reversal Advance: The breakout occurred with a strong move above resistance at 22 with 2 weeks of strong volume (green arrows). The advance began from 17.44 and ended at 35.92.
• Consolidation/Correction: After an extended advance, the stock declined within a set range that resembled a large descending flag. The decline retraced about 54% of the previous advance.
• Continuation Advance – Length: The estimated length of the advance was 18.48 points from the June low at 25.94, which would target 44.42. The actual high was 44.75 for a 18.81 advance.
• Continuation Advance – Entry: Because the consolidation/correction portion formed a continuation pattern, entry could have been based on a break above the resistance line (red arrow).
• Volume: Volume increased in early November at the beginning of the reversal advance. There was a decrease from March to May 1999. And, volume increased at the beginning of the continuation advance (green arrows).

Source: Stock Charts

Price Channel (Continuation)

A price channel is a continuation pattern that slopes up or down and is bound by an upper and lower trend line. The upper trend line marks resistance and the lower trend line marks support. Price channels with negative slopes (down) are considered bearish and those with positive slopes (up) bullish. For explanatory purposes, a “bullish price channel” will refer to a channel with positive slope and a “bearish price channel” to a channel with negative slope.

1. Main Trend Line: It takes at least two points to draw the main trend line. This line sets the tone for the trend and the slope. For a bullish price channel, the main trend line extends up and at least two reaction lows are required to draw it. For a bearish price channel, the main trend line extends down and at least two reaction highs are required to draw it.
2. Channel Line: The line drawn parallel to the main trend line is called the channel line. Ideally, the channel line will be based off of two reaction highs or lows. However, after the main trend line has been established, some analysts draw the parallel channel line using only one reaction high or low. The channel line marks support in a bearish price channel and resistance in a bullish price channel.
3. Bullish Price Channel: As long as prices advance and trade within the channel, the trend is considered bullish. The first warning of a trend change occurs when prices fall short of channel line resistance. A subsequent break below main trend line support would provide further indication of a trend change. A break above channel line resistance would be bullish and indicate an acceleration of the advance.
4. Bearish Price Channel: As long as prices decline and trade within the channel, the trend is considered bearish. The first warning of a trend change occurs when prices fail to reach channel line support. A subsequent break above main trend line resistance would provide further indication of a trend change. A break below channel line support would be bearish and indicate an acceleration of the decline.
5. Scaling: Even though it is a matter of personal preference, trend lines seem to match reaction highs and lows best when semi-log scales are used. Semi-log scales reflect price movements in percentage terms. A move from 50 to 100 will appear the same distance as a move from 100 to 200.

In a bullish price channel, some traders look to buy when prices reach main trend line support. Conversely, some traders look to sell (or short) when prices reach main trend line resistance in a bearish price channel. As with most price patterns, other aspects of technical analysis should be used to confirm signals.

Because technical analysis is just as much art as it is science, there is room for flexibility. Even though exact trend line touches are ideal, it is up to each individual to judge the relevance and placement of both the main trend line and the channel line. By that same token, a channel line that is exactly parallel to the main trend line is ideal.

CSCO provides an example of an 11-month bullish price channel that developed in 1999.

• Main Trend Line: The January, February and March reaction lows formed the beginning of the main trend line. Subsequent lows in April, May and August confirmed the main trend line.
• Channel Line: Once the main trend line was in place, the channel line beginning from the January high was drawn. A visual assessment reveals that these trend lines look parallel. More precise analysts may want to test the slope of each line, but a visual inspection is usually enough to ensure the “essence” of the pattern.
• Bullish Price Channel: Subsequent touches along the main trend line offered good buying opportunities in mid April, late May and mid August.
• The stock did not reach channel line resistance until July (red arrow) and this marked a significant reaction high.
• The September high (blue arrow) fell short of channel line resistance, but only by a small margin that was probably insignificant.
• The break above channel line resistance in Dec-99 marked an acceleration of the advance. Some analysts might consider the stock overextended after this move, but the advance was powerful and the trend never turned bearish. Price channels will not last forever, but the underlying trend remains in place until proved otherwise.

Source: Stock Charts

Trend Lines

Technical analysis is built on the assumption that prices trend. Trend Lines are an important tool in technical analysis for both trend identification and confirmation. A trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance. Many of the principles applicable to support and resistance levels can be applied to trend lines as well. It is important that you understand all of the concepts presented in our Support and Resistance article before you continue.

Definition

Uptrend Line

An uptrend line has a positive slope and is formed by connecting two or more low points. The second low must be higher than the first for the line to have a positive slope. Uptrend lines act as support and indicate that net-demand (demand less supply) is increasing even as the price rises. A rising price combined with increasing demand is very bullish, and shows a strong determination on the part of the buyers. As long as prices remain above the trend line, the uptrend is considered solid and intact. A break below the uptrend line indicates that net-demand has weakened and a change in trend could be imminent.

Downtrend Line

A downtrend line has a negative slope and is formed by connecting two or more high points. The second high must be lower than the first for the line to have a negative slope. Downtrend lines act as resistance, and indicate that net-supply (supply less demand) is increasing even as the price declines. A declining price combined with increasing supply is very bearish, and shows the strong resolve of the sellers. As long as prices remain below the downtrend line, the downtrend is solid and intact. A break above the downtrend line indicates that net-supply is decreasing and that a change of trend could be imminent.

For a detailed explanation of trend changes, which are different than just trend line breaks, please see our article on the Dow Theory.

Scale Settings

High points and low points appear to line up better for trend lines when prices are displayed using a semi-log scale. This is especially true when long-term trend lines are being drawn or when there is a large change in price. Most charting programs allow users to set the scale as arithmetic or semi-log. An arithmetic scale displays incremental values (5,10,15,20,25,30) evenly as they move up the y-axis. A $10 movement in price will look the same from $10 to $20 or from $100 to $110. A semi-log scale displays incremental values in percentage terms as they move up the y-axis. A move from $10 to $20 is a 100% gain, and would appear to be a much larger than a move from $100 to $110, which is only a 10% gain.

Drawing Trend Lines on Tricom Trader

In the case of EMC, there was a large price change over a long period of time. While there were not any false breaks below the uptrend line on the arithmetic scale, the rate of ascent appears smoother on the semi-log scale. EMC doubled three times in less than two years. On the semi-log scale, the trend line fits all the way up. On the arithmetic scale, three different trend lines were required to keep pace with the advance.

In the case of Amazon.com (AMZN), there were two false breaks above the downtrend line as the stock declined during 2000 and 2001. These false break outs could have led to premature buying as the stock continued to decline after each one. The stock lost 60% of its value three times over a two year period. The semi-log scale reflects the percentage loss evenly, and the downtrend line was never broken.

Validation

It takes two or more points to draw a trend line The more points used to draw the trend line, the more validity attached to the support or resistance level represented by the trend line. It can sometimes be difficult to find more than 2 points from which to construct a trend line Even though trend lines are an important aspect of technical analysis, it is not always possible to draw trend lines on every price chart. Sometimes the lows or highs just don’t match up, and it is best not to force the issue. The general rule in technical analysis is that it takes two points to draw a trend line and the third point confirms the validity.

The chart of Microsoft (MSFT) shows an uptrend line that has been touched 4 times. After the third touch in Nov-99, the trend line was considered a valid line of support. Now that the stock has bounced off of this level a fourth time, the soundness of the support level is enhanced even more. As long as the stock remains above the trend line (support), the trend will remain in control of the bulls. A break below would signal that net-supply was increasing and that a change in trend could be imminent.

Spacing of Points

The lows used to form an uptrend line and the highs used to form a downtrend line should not be too far apart, or too close together. The most suitable distance apart will depend on the time frame, the degree of price movement, and personal preferences. If the lows (highs) are too close together, the validity of the reaction low (high) may be in question. If the lows are too far apart, the relationship between the two points could be suspect. An ideal trend line is made up of relatively evenly spaced lows (or highs). The trend line in the above MSFT example represents well-spaced low points.

On the Wal-Mart (WMT)example, the second high point appears to be too close to the first high point for a valid trend line; however, it would be feasible to draw a trend line beginning at point 2 and extending down to the February reaction high.

Angles

As the steepness of a trend line increases, the validity of the support or resistance level decreases. A steep trend line results from a sharp advance (or decline) over a brief period of time. The angle of a trend line created from such sharp moves is unlikely to offer a meaningful support or resistance level. Even if the trend line is formed with three seemingly valid points, attempting to play a trend line break or to use the support and resistance level established it will often prove difficult.

The trend line for Yahoo! (YHOO)was touched four times over a 5-month period. The spacing between the points appears OK, but the steepness of the trend line is unsustainable, and the price is more likely than not to drop below the trend line. However, trying to time this drop or make a play after the trend line is broken is a difficult task. The amount of data displayed and the size of the chart can also affect the angle of a trend line. Short and wide charts are less likely to have steep trend lines than long and narrow charts. Keep that in mind when assessing the validity and sustainability of a trend line.

Internal Trend Lines

Sometimes there appears to be the possibility for drawing a trend line, but the exact points do not match up cleanly. The highs or lows might be out of whack, the angle might be too steep or the points might be too close together. If one or two points could be ignored, then a fitted trend line could be formed. With the volatility present in the market, prices can over-react, and produce spikes that distort the highs and lows. One method for dealing with over-reactions is to draw internal trend lines. Even though an internal trend line ignores price spikes, the ignoring should be within reason.

The long-term trend line for the S&P 500 ($SPX) extends up from the end of 1994, and passes through low points in Jul-96, Sept-98 and Oct-98. These lows were formed with selling climaxes, and represented extreme price movements that protrude beneath the trend line. By drawing the trend line through the lows, the line appears to be at a reasonable angle, and the other lows match up extremely well.

Sometimes, there is a price cluster with a high or low spike sticking out. A price cluster is an area where prices are grouped within a tight range over a period of time. The price cluster can be used to draw the trend line, and the spike can be ignored. The Coca Cola (KO) chart shows an internal trend line that is formed by ignoring price spikes and using the price clusters, instead. In October and November 1998, Coke formed a peak, with the November peak just higher than the October peak (1). If the November peak had been used to draw a trend line, then the slope would have been more negative, and there would have appeared to be a breakout in Dec-98 (gray line). However, this would have only been a two-point trend line, because the May-June highs are too close together (black arrows). Once the Dec-99 peak formed (green arrow), it would have been possible to draw an internal trend line based on the price clusters around the Oct/Nov-98 and the Dec-99 peaks (blue line). This trend line is based on three solid touches, and it accurately forecasts resistance in Jan-00 (blue arrow).

Conclusion

Trend lines can offer great insight, but if used improperly, they can also produce false signals. Other items – such as horizontal support and resistance levels or peak-and-trough analysis – should be employed to validate trend line breaks. While trend lines have become a very popular aspect of technical analysis, they are merely one tool for establishing, analyzing, and confirming a trend. Trend lines should not be the final arbiter, but should serve merely as a warning that a change in trend may be imminent. By using trend line breaks for warnings, investors and traders can pay closer attention to other confirming signals for a potential change in trend.

The uptrend line for VeriSign (VRSN) was touched 4 times, and seemed to be a valid support level. Even though the trend line was broken in Jan-00, the previous reaction low held, and did not confirm the trend line break. In addition, the stock recorded a new higher high prior to the trend line break.

Support and Resistance

Support and resistance represent key junctures where the forces of supply and demand meet. In the financial markets, prices are driven by excessive supply (down) and demand (up). Supply is synonymous with bearish, bears and selling. Demand is synonymous with bullish, bulls and buying. These terms are used interchangeably throughout this and other articles. As demand increases, prices advance and as supply increases, prices decline. When supply and demand are equal, prices move sideways as bulls and bears slug it out for control.

What Is Support?

Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.

Support does not always hold and a break below support signals that the bears have won out over the bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive to buy. Support breaks and new lows signal that sellers have reduced their expectations and are willing sell at even lower prices. In addition, buyers could not be coerced into buying until prices declined below support or below the previous low. Once support is broken, another support level will have to be established at a lower level.

Where Is Support Established?

Support levels are usually below the current price, but it is not uncommon for a security to trade at or near support. Technical analysis is not an exact science and it is sometimes difficult to set exact support levels. In addition, price movements can be volatile and dip below support briefly. Sometimes it does not seem logical to consider a support level broken if the price closes 1/8 below the established support level. For this reason, some traders and investors establish support zones.

What Is Resistance?

Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. The logic dictates that as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance.

Resistance does not always hold and a break above resistance signals that the bulls have won out over the bears. A break above resistance shows a new willingness to buy and/or a lack of incentive to sell. Resistance breaks and new highs indicate buyers have increased their expectations and are willing to buy at even higher prices. In addition, sellers could not be coerced into selling until prices rose above resistance or above the previous high. Once resistance is broken, another resistance level will have to be established at a higher level.

Where Is Resistance Established?

Resistance levels are usually above the current price, but it is not uncommon for a security to trade at or near resistance. In addition, price movements can be volatile and rise above resistance briefly. Sometimes it does not seem logical to consider a resistance level broken if the price closes 1/8 above the established resistance level. For this reason, some traders and investors establish resistance zones.

Drawing Support and Resistance Lines on Tricom Trader

Methods to Establish Support and Resistance?

Support and resistance are like mirror images and have many common characteristics.

Highs and Lows

Support can be established with the previous reaction lows. Resistance can be established by using the previous reaction highs.

The above chart for Halliburton (HAL) shows a large trading range between Dec-99 and Mar-00. Support was established with the October low around 33. In December, the stock returned to support in the mid-thirties and formed a low around 34. Finally, in February the stock again returned to the support scene and formed a low around 33 1/2.

After each bounce off support, the stock traded all the way up to resistance. Resistance was first established by the September support break at 42.5. After a support level is broken, it can turn into a resistance level. From the October lows, the stock advanced to the new support-turned-resistance level around 42.5. When the stock failed to advance past 42.5, the resistance level was confirmed. The stock subsequently traded up to 42.5 two more times after that and failed to surpass resistance both times.

Support Equals Resistance

Another principle of technical analysis stipulates that support can turn into resistance and visa versa. Once the price breaks below a support level, the broken support level can turn into resistance. The break of support signals that the forces of supply have overcome the forces of demand. Therefore, if the price returns to this level, there is likely to be an increase in supply, and hence resistance.

The other turn of the coin is resistance turning into support. As the price advances above resistance, it signals changes in supply and demand. The breakout above resistance proves that the forces of demand have overwhelmed the forces of supply. If the price returns to this level, there is likely to be an increase in demand and support will be found.

In this example of the NASDAQ 100 Index ($NDX), the stock broke resistance at 935 in May-97 and traded just above this resistance level for over a month. The ability to remain above resistance established 935 as a new support level. The stock subsequently rose to 1150, but then fell back to test support at 935. After the second test of support at 935, this level is well established.

From the PeopleSoft (PSFT) example, we can see that support can turn into resistance and then back into support. PeopleSoft found support at 18 from Oct-98 to Jan-99 (green oval), but broke below support in Mar-99 as the bears overpowered the bulls. When the stock rebounded (red oval), there was still overhead supply at 18 and resistance was met from Jun-99 to Oct-99.

Where does this overhead supply come from? Demand was obviously increasing around 18 from Oct-98 to Mar-99 (green oval). Therefore, there were a lot of buyers in the stock around 18. When the price declined past 18 and to around 14, many of these buyers were probably still holding the stock. This left a supply overhang (commonly known as resistance) around 18. When the stock rebounded to 18, many of the green-oval-buyers (who bought around 18) probably took the opportunity to sell. When this supply was exhausted, the demand was able to overpower supply and advance above resistance at 18.

Trading Range

Trading ranges can play an important role in determining support and resistance as turning points or as continuation patterns. A trading range is a period of time when prices move within a relatively tight range. This signals that the forces of supply and demand are evenly balanced. When the price breaks out of the trading range, above or below, it signals that a winner has emerged. A break above is a victory for the bulls (demand) and a break below is a victory for the bears (supply).

After an extended advance from 27 to 64, WorldCom (WCOM) entered into a trading range between 55 and 63 for about 5 months. There was a false breakout in mid-June when the stock briefly poked its head above 62 (red oval). This did not last long and a gap down a few days later nullified the breakout (black arrow). The stock then proceeded to break support at 55 in Aug-99 and trade as low as 50. Here is another example of support turned resistance as the stock bounced off 55 two more times before heading lower. While this does not always happen, a return to the new resistance level offers a second chance for longs to get out and shorts to enter the fray.

In Nov/Dec-99, Lucent Technologies (LU) formed a trading range that resembled a head and shoulders pattern (red oval). When the stock broke support at 60, there was little or no time to exit. Even though the there is a long black candlestick indicating an open at 59, the stock fell so fast that it was impossible to exit above 44. In hindsight, the support line could have been drawn as an upward sloping neckline (blue line), and the support break would have come at 61. This is only 1 point higher and a trader would have had to take action immediately to avoid a sharp fall. However, the lows match up rather nicely on the neckline, and it is something to consider when drawing support lines.

After Lucent declined, a trading range was established between 40.5 and 47.5 for almost two months (green oval). The resistance level of the trading range was well marked by three reaction peaks at 47.5. The support level was not as clearly marked, but appeared to be between 40 and 41. Some buying interest began to become evident around 44 in mid- to late-February. Notice the array of candlesticks with long lower shadows, or hammers, as they are known. The stock then proceeded to form two up gaps on 24-Feb and 25-Feb, and finally closed above resistance at 48. This was a clear indication of demand winning out over supply. There were still two more opportunities (days) to get in on the action. On the third day after the breakout, the stock gapped up and moved above 56.

Support and Resistance Zones

Because technical analysis is not an exact science, it is useful to create support and resistance zones. This is contrary to the strategy mapped out for Lucent Technologies (LU), but it is sometimes the case. Each security has its own characteristics, and analysis should reflect the intricacies of the security. Sometimes, exact support and resistance levels are best, and, sometimes, zones work better. Generally, the tighter the range, the more exact the level. If the trading range spans less than 2 months and the price range is relatively tight, then more exact support and resistance levels are best suited. If a trading range spans many months and the price range is relatively large, then it is best to use support and resistance zones. These are only meant as general guidelines, and each trading range should be judged on its own merits.

Returning to the analysis of Halliburton (HAL), we can see that the November high of the trading range (33 to 44) extended more than 20% past the low, making the range quite large relative to the price. Because the September support break forms our first resistance level, we are ready to set up a resistance zone after the November high is formed, probably around early December. At this point though, we are still unsure if a large trading range will develop. The subsequent low in December, which was just higher than the October low, offers evidence that a trading range is forming, and we are ready to set the support zone. As long as the stock trades within the boundaries set by the support and resistance zone, we will consider the trading range to be valid. Support may be looked upon as an opportunity to buy, and resistance as an opportunity to sell.

Conclusion

Identification of key support and resistance levels is an essential ingredient to successful technical analysis. Even though it is sometimes difficult to establish exact support and resistance levels, being aware of their existence and location can greatly enhance analysis and forecasting abilities. If a security is approaching an important support level, it can serve as an alert to be extra vigilant in looking for signs of increased buying pressure and a potential reversal. If a security is approaching a resistance level, it can act as an alert to look for signs of increased selling pressure and potential reversal. If a support or resistance level is broken, it signals that the relationship between supply and demand has changed. A resistance breakout signals that demand (bulls) has gained the upper hand and a support break signals that supply (bears) has won the battle.

Source: Stock Chart

Forex Technical Analysis

The difference between forex technical and forex fundamental analysis is that forex technical analysis ignores fundamental factors and is applied only to the price action of the market. Forex technical analysis primarily consists of a variety of forex technical studies, each of which can be interpreted to predict market direction or to generate buy and sell signals. The technical analysis works by correlating the results and moves of current markets to create a short-term outlook for currencies. The rolling data that is produced throughout the trading day creates the interest in the markets and informs traders of the strong markets to back.The Trend is Your Friend

Forex technical analysis is largely based around forex market movement trends, thus creating the widely used phrase ‘the trend is your friend’ amongst traders. Buying and selling at the right time is the key in maintaining good levels of profits, following a trend is also about knowing where to entry a trade and more importantly where to exit.

Support and Resistance

Support and resistance is the basic of forex technical analysis. Support and resistance levels are points where a chart experiences recurring upward or downward pressure. A support level is usually the low point in any chart pattern (hourly, weekly or annually), whereas a resistance level is the high or the peak point of the pattern. Buying and selling at the support and resistance points makes a greater profit margin as long as they remain unbroken.

History Tends To Repeat Itself

Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time. Forex technical analysis uses chart patterns to analyze forex market movements and understand trends. Although many of these charts have been used for more than 30 years, they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves.