Sunday, February 17, 2013

Support and Resistance (Range Trading) Strategy

Support and Resistance (Range Trading) Strategy

The concept of support and resistance trading or range trading is simple: buy when the price of the currency pair is at a valid support level and sell when the currency pair is at a valid resistance level. The key is therefore being able to identify support and resistance and when these key levels are valid enough to be used as trade signals.

A support level or zone is a price area where sellers who have driven prices downwards start to exit their positions, leaving more buyers to cause the downward slide of prices to stall. The Price of the asset will therefore find it difficult to go below that level.
For a support to be valid, it must be tested several times and be able to withstand downward pressure several times. Even if a one hour chart or a daily chart shows support being tested once, a look at the lower time frame charts such as the 1 minute, 5 minute or 15 minute charts will show if the price level has been tested several times or not. A valid support level is one that has been tested several times without being breached.
A breach of the support turns that level into a resistance level.
A resistance level or zone is a price area where buyers whose activity has driven prices upwards start to close their positions, causing a stall in the price advance of the asset. The price of the asset will therefore find it difficult to advance above that level.
For a resistance to be valid, it must be tested severally without being breached, and even if a medium or long term chart shows resistance being tested once or twice, the shorter time frame charts will reveal that the price level may have indeed been tested several times. The more times a resistance level is tested without being breached, the more valid it is. The chart below shows a resistance and support level.
Support Resistance Strategy
A breach of the resistance turns that level into a support level.
Support Becoming Resistance
Support Becoming Resistance
Trading Support and Resistance
Contract the charts using the zoom tool, so that you have a wide range of prices to examine. Then using medium and long term charts such as the 4hour chart and daily chart, you can identify areas of support and resistance, and then use these areas to trade as follows:
  • The first trade is to enter long at support and exit at resistance as the first profit target. If the move is strong enough to breach the resistance (i.e. bullish candle closes above it), then you can place a Buy Limit order at the resistance-turned support so that the retreating prices that will stall at that level will serve as a trigger for a renewed upward move. The 2nd profit target should then be the next resistance.
  • In the same vein, you can go short at resistance and exit at the nearest support as first profit target. If the move is strong enough to breach the support with a bearish candle closing below the support level, place a Sell Limit so that a retracement advance will hit the support now turned resistance, and trigger your trade for the further move to the downside. The second profit target is now the next support.
Please note that the prices may test the levels several times before eventually breaking them. So always wait for confirmation of a break of support or resistance before taking the second trade in each case.
Support Resistance Strategy
This chart illustrates a short order using our trade description. The area marked support would be the first target from the obvious downtrend which the trader would have gone short earlier on. The support was not broken, so the trader should have exited the trade at this point. Prices retreated upwards before testing the support again, this time breaching it (notice the red candle closing below the support). There were then several attempts by the price to go back to where they came from, but the support now turned resistance resisted these moves, and prices moved downwards (took a while though). Later attempts by the price retracement to breach the new resistance twice did not work.
This is how to trade using the support and resistance strategy.

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