A support level is a concept in technical analysis, indicating when an asset has reached a price level that market participants are unwilling to continue selling, which causes the price to stop falling.
Support is a price level where downward movement may be restrained by accumulated demand at or around that price level.
A support level is a price level at which an asset may find difficulty falling below as traders look to buy around that level.
More and more buyers are active the closer the price gets to the support level.
Understanding Support Levels
Support can be described as:
- A price level at which an asset has trouble falling below.
- A price level at which buying is expected to take place.
At its core, ‘support’ in trading denotes a price level where a currency pair’s downward trend may pause due to increased demand or buying interest.
As the price approaches this support level, it is anticipated that demand will start to outweigh supply and prevent the price from falling below that level.
Usually, the markets prove unwilling to let an asset drop below its support level, with buyers stepping in to raise the asset’s price higher again.
That makes them the opposite of resistance levels, which is a price level at which the markets prove unwilling to let an asset’s price rise any higher.
If an asset does move below its support level, then that support level has “been broken“.
Knowing where an asset’s support and resistance levels are can help traders choose the best time to enter a market, as well as where to put stops and limits.
Support levels are frequently established by previous lows on a price chart. They represent points where the market has shown a strong reaction in the past.
For instance, if each time the EUR/USD pair dips to 1.1000, buyers step in and push the price back up, 1.1000 would be seen as a support level.
However, support levels aren’t static and can be breached, particularly during strong bearish (downward) movements.
If the price breaks below a support level, it can often lead to a significant drop as that support level morphs into a resistance level, a point at which the market has shown a strong sell-off historically.
Applying Support Levels in Forex Trading
Support levels play a crucial role in forex trading strategies, particularly those based on technical analysis.
Traders use these levels to help determine when to enter a trade, expecting the price to rebound from the support level.
For example, if a trader identifies that the GBP/USD pair has a strong support level at 1.2000, they might decide to buy the pair each time it dips close to this level, anticipating that it will bounce back.
Support levels also aid in managing risk by providing a logical place to set a stop-loss order.
In the above example, if a trader bought GBP/USD at 1.2020, expecting a bounce at the 1.2000 support level, they might set a stop-loss order slightly below this level, say at 1.1980, to limit potential losses if the support level were broken.
Interpreting Broken Support Levels
As stated, support levels aren’t invincible barriers, and prices can break through them.
A breach of a support level signals that the bears (sellers) have won over the bulls (buyers) at a particular price level.
Once a support level is broken, it often becomes a new resistance level.
For example, if that 1.2000 support level in GBP/USD were broken and the price fell to 1.1950, the 1.2000 level might now act as a resistance level, preventing the price from moving back up.
Summary
Support levels represent a fundamental concept in technical analysis.
They provide a measure of the price levels at which a currency pair’s decline could be halted due to increased demand.
Identifying these levels can help you make informed decisions about when to enter or exit a trade.
However, it’s crucial to note that support levels, like any other trading tool, aren’t infallible.
Market conditions can and do change, and what works in one scenario may not work in another.