Support and resistance lines are fictional points on price charts where prices have historically been reluctant to go above or below. They are fictional, yes, but they hold a lot of psychological power over traders. In theory, these points signify an exact location where supply and demand meet, but this isn’t always true. What is true is that when a price stalls out for an extended period of time, traders tend to behave in a certain manner. When it’s at a low point, it’s believed that prices will go back up soon, and when it’s at a high point, prices will probably drop back down to a more realistic level. This is not always the case, though, so you cannot just blindly follow this advice.
Prices break through support and resistance lines all the time. Knowing when this will happen is going to help you to beat out thousands of other traders that are not aware of this fact. The tough part of figuring this out is that you need to look at other forms of analysis to get a better picture of this concept. This is where fundamental analysis becomes very helpful. For example, let’s say that currency pair ABC/XYZ has had a resistance line that it’s been toying with for a few months. Every time it gets up to .8500, it stalls out for a few days before dropping back down to a more sustainable price. This is usually a good thing for short sellers, since they know that it is extremely unlikely that prices will go above that point. So when it hits .85, a short sale is initiated and then positions are covered once the expected drop in price takes place.
But now consider the fact that at this most recent arrival at the resistance line, Country ABC announced that they have a highly anticipated new policy that is going to be put into motion six months earlier than originally thought. So now prices are at .8350 and climbing rapidly. Is that .8500 mark going to be the high point again?
Probably not. Resistance lines are highly dependent upon the country’s economic circumstances, and if a new policy is expected to do well and influence currency prices, it is more than likely that the .85 mark will be smashed once the policy is going forward. What happens after this is up to investors and consumers, however. If the policy does really well, the sky’s the limit. Prices could go up to .9500 or higher. How long this happens for is up to debate, though. But even if the rise in price is only for a day or two, there’s no reason why you cannot profit off of it. Just time things right and pay attention to both the technical and fundamental sides of support and resistance lines.
So while support and resistance lines appear to be solely technical indicators, they really are not. A savvy trader will know this and anticipate which side of things to rely upon more heavily when forming a trading decision. It does require a little bit of extra work, but in the end, the extra work will more than pay for itself when you see a big increase in your profits.