Let me divide the good traders from the bad for a minute, there are those that are confused about trading, almost to the borderline of gambling and there are those traders that wait for trade opportunities to come to them.. The difference can be the line drawn in the sand to who makes money in this business to those that just get by.
That is where understanding support and resistance come in. And i do not mean some meaningless indicator that automatically plots it.. I mean the manual application of knowing these areas and seeing them yourself.
If you are unsure on how to draw high probability support and resistance then read my post on it here. This is crucial for understanding and benefiting from this post.
Okay so back to the question?
First of all let me answer why would one focus on learning how to see support and resistance? The reason being is this is where the money making traders trade and so if you want to make money in this business then you too have to copy them rather than the crowd, and let me tell you many, many traders ignore support and resistance and they lose money time and time again.. They may have winning streaks, but that is it.
Now, why do these areas work, okay this is important because support and resistance are test areas, not necessarily trades. We set alarms there and see what price does, if it bounces we wait some more and then assess what price it bounced at. Now here is the crucial thing, when price bounces at a support let’s say most good traders will notice this as well, they are doing the same, a certain amount of them wish they had gotten in there even when it has only bounced say 10 to 20 pips..
Because they feel they missed out on the opportunity this now becomes an even higher probability order for where it bounced previously.. Why, you may ask? Well, because those waiting for confirmation now see confirmation where it bounced and so now feel more confident it will hold, so commonly price will retrace to that support again.. Now, what happens once it retraces. Oftentimes then price will literally rocket higher and thus you make more profit with less risk. You see, you could of put your order in straight away for that price, but do you now see the risk of doing that if it had broken, instead you waited patiently for price alarm, saw price bounce at the support number ten to twenty pips and then created an order for where it previously bounced at this major support.
So, in a nutshell it bounces again because the psychology of traders is predictable, they trade because now they want to be in on the second bounce. Sometimes price may even bounce three times and then rocket, this is because each bounce is a conviction for a trader in Forex and so each time it bounces there is a higher chance of a good bounce profit play..
Now, let’s take a look at the opposition in this scenario..
When support breaks the majority of traders that placed orders at that support feel loss, they feel upset and feel if price goes back even a little in there favor they will close.. This is called fear of loss, but in another sense it gives strength of this previous support now being a strong resistance once broken. So once price retraces back to hit the bottom of the support that traders cuts there trade and thus that support becomes resistance.
Confirmed in a way due to fear. There is also the trader that sees the important support broken and feels they missed out on an opportunity selling, so they place an order to sell just below the broken area, they feel that they missed that one so if it retraces, well i will get in then. This in turn creates conviction for this now being a resistance zone and thus created with psychology alone..
Above – Example shown on recent EURUSD chart, click on image for larger view.
Do you see how this works?
The trader is actually creating these zones with fear of loss and fear of a missed opportunity. These two attributes are common drivers in this world and so must be taken notice of to make money. So lastly that comes back to my original point, support and resistance work in Forex because people are predictable and fear is predictable. There is no real losing trades, it is mostly psychological, however by understanding this psychology you will become a much better trader without risking as much on each trade entry.
Remember the key notes on this post are firstly wait for major h4 or daily supports as i have shown how to draw. Then secondly wait for it to bounce once.. After it bounces and you see it respected it then place an order to trade around the confirmed support or resistance. Over 80% of the time price will always test twice and around 60% it will test three times, this does not mean price will not break that support or resistance, that is still possible, however in most situations, it will break properly almost straight away and so you would not be in the trade due to waiting for a bounce confirmation in the first place. A key factor in managing RISK.
I hope this helps for some to understand better why these areas work, if you have any questions on this one feel free to comment below your thoughts.