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Support and Resistance

Support and resistance for a currency pair at certain price levels comes from several different sources. 

Either barrier is always at least somewhat psychological in nature.  Given this, it helps to explain resistance and support by picturing the market as a contest of strength between the bears and the bulls.

Let's use a classic example of a purely psychological barrier: oil at $100/a barrel  Of course, economic fundamentals are important in determining the long term price of a commodity like oil, but the market's current mood and focus are much more important in terms of short term price gyrations. 

As geopolitical tensions mounted, and a renewal of focus on the rising long-term demand for oil started to flash itself across the TV screen on a nightly basis, traders were pushing oil closer and closer to $100 a barrel.  Each time the bulls got close, though, they would begin to encounter resistance  The notion of $100 a barrel just seemed a little crazy to too many people.  So, the bears would start to gain the upper hand and a mild sell-off would occur.  This didn't last long, of course... oil now rests well above a hundred dollars a barrel.  But the point is, arbitrarily round number points sometimes provide support or resistance to a currency, commodity, or stock price. 

Currency traders often produce trend lines of a stock by drawing a straight line through as many high or low points as can be found on a linear path.  Plotting that line into the future will often give the market a sense of where the currency pair is going, and thus will create either resistance or support for a currency along that line. 

The same can be said about moving averages, which most forex trading sites will graph for you with a click of a button.  Moving averages – as well as bollinger bands – will often be used by the market to determine where those in the middle will ally with the bulls or with the bears. 

With all of these sources of resistance or support – round numbers, moving averages, bollinger bands, linear high and low lines, etc. – the market creates that resistance or support.  It is important to remember that resistance and support do not come from any economic fundamentals inherent in a currency pair or any other item that is being traded. 

Rather, because trader believes report or resistance exists somewhere, it does.  In fact, it is often the economic fundamentals that end up finally forcing the market to push a currency pair above or below resistance or support levels. 

So, the longer a point of resistance has been around, the stronger it usually is.  Conversely, once people start talking about an historic resistance or support point being broken, a self-fulfilling dynamic can be created. 

Once a strong resistance point is broken, a strong trend one way or the other often occurs at this point, as traders experiment and try to find a new source of support or resistance  When the new point is finally found, volatility usually dies down for a bit, until the next event occurs that moves the market.

As a general rule, points of resistance and support are much more important to those practicing short term trading, especially swing traders, than it is to longer term traders.  Because resistance levels are largely a psychologically created phenomenon removed from economic fundamentals, they only last so long, and tend not to effect the long-term value of a currency pair.