Support and Resistance

Technical Analysis | by Dailyfx.com | Thursday, 18 March 2010 05:00 UTC
Of all the strategies used to identify an entry into a trade, the use of support and resistance may be one of the more reliable.

A move up through resistance or down through support serves as some sort of confirmation of the move and any time you get confirmation of a move you increase the chance of success on the trade. There are many ways to identify support and resistance but one of the more popular and simplest ways is to use previous highs and lows on the chart.

The EUR/USD daily chart shows a downtrend, so we want to take advantage of that momentum and look for sells. A solid sell setup is a rally up to resistance and a reversal. However, identifying that reversal can be tricky. This is where a move down through a support level can offer great value in this approach. A move down to the EUR/USD 4-hour chart shows the market is moving up in a series of higher highs and higher lows.


What we want to see is a series of lower highs and lower lows in a downtrend. So a move down through one of the lows, which is identified as support, could be the reversal we look for in a trade entry. Right now I see the current support at the 1.3642 low of March 15th. A move down through that level should open the door to more selling and a resumption of the downtrend. That would be an ideal sell entry. I highlighted the word "should" for a reason as we never now how the market will react once we get into a trade. A scheduled or unscheduled news release are just two examples of what can change sentiment quickly. So we should expect to lose half of our trades even when we identify a solid trading opportunity. So we need to place a protective stop in the market with our entry. If the EUR/USD were to move back up through this current high, we can then assume that something has changed and we need to be out of our sell position. So placing our initial protective buy stop above the high before our entry is also a good choice. That defines our risk and leaves us with just one more decision; where to exit with a profit. Well if we lose half of our trades, we have to make more when we are right than we lose when we are wrong, so the use of a simple 1:2 risk:reward ratio is also a solid choice. If we risk 150 pips on the trade, we should look for at least 300 pips in profit. We can look for twice that risk in profit because we are trading with the trend and the momentum of the market. Trading against the trend does not offer this same opportunity. Many traders will also trail their stop to further limit their risk. When/if the market moves halfway to their 300 pip taget, they will move their stop down to the breakeven level. Then they can either gain the full 300 pips or break even on the trade. That is a great position to be in as a trader.

Written by Dailyfx.com


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