The only way to profit from the forex market is to know its future direction.
But how can one know the future without a crystal ball? In the financial markets, such crystal balls exist in the form of support and resistance levels.
Here’s a pro tip – use moving averages as the basis for your support and resistance. This creates flexible and reactive levels for maximized profits.
With an asset’s smoothed price average, you form a band that indicates the underlying trend movement. When used as a (dynamic) support and resistance, your reference to the prevailing price action is adaptable to the volatile price action.
Support and resistance levels represent price points where currency pairs historically tend to reverse or pause. This trait alone makes S/R levels critical for technical analysis.
These levels are not random but arise from market psychology, order flows, and trading activity around key price zones.
You can improve your accuracy and timing only when you effectively recognize and understand these levels.
Support levels act as “floors” where the price of a currency pair stops falling and reverses upward.
For example, if the EUR/USD pair consistently bounces back after reaching 1.0500, that price point becomes a strong support level.
Support level forms due to buyers’ intervention as they see value at these levels. Additionally, sellers reduce downward pressure by locking in or taking profits from their short positions.
Traders seek buying opportunities as the price approaches support levels. They anticipate that the price will bounce upward once again.
Resistance levels are the opposite—they act as “ceilings” where the price often struggles to rise further.
For instance, if GBP/USD repeatedly fails to break above 1.2800, this level becomes a key resistance zone.
Sellers may increase activity at resistance points, expecting the price to reverse downward.
Forex traders often use these zones to take short positions or place stop-loss orders above the resistance in case of a breakout.
Read more: TradersUnited – What Are Support and Resistance Levels in Forex?
Moving averages (MAs) are among the most popular technical analysis tools for forex trading. They smooth out price data and reveal trends, making them invaluable for traders.
MA is a statistical calculation that smooths out price data over a specified period. By averaging the prices, it eliminates noise and provides a better perspective of the market trend.
The Simple Moving Average (SMA) and Exponential Moving Average (EMA) are the two common types of moving averages.
While the two function to provide a better picture of the prevailing market trend, the two differ significantly.
Support and resistance levels are typically categorized into two main types: linear and dynamic.
Both the linear and dynamic S/R levels serve a specific purpose and provide unique insights into market movements, making them indispensable tools for any forex trader.
Traditional (linear) support and resistance levels are fixed price points derived from historical highs and lows. While they can be effective, they don’t adapt to rapidly changing market conditions.
Dynamic support and resistance, such as those formed by moving averages, evolve with the price. This makes them highly adaptable to trends and offers a real-time perspective on price action.
These levels are particularly useful in the forex market because they adapt to changing price trends, making them more reliable during periods of volatility or trend shifts.
For example, a 20-period moving average can provide real-time insights into short-term support and resistance during high-impact news events like central bank announcements, elections, and geopolitical tensions.
Again, an MA-derived support and resistance level creates a dynamic indicator for trend spotting.
Here are the three steps to identify a dynamic support and resistance level:
Choose a moving average length that aligns with the predetermined trading timeframe.
If you’re trying to spot short-term trends, you must use a relatively shorter timeframe. It includes 10, 20, or 50-period moving averages.
Medium-term traders often use 100-period moving averages. Meanwhile, 200-period moving averages are used by long-term traders as they are effective in identifying the primary price trend.
Now, you need to observe how the price interacts with the moving average (or the dynamic S/R level). Only then can you interpret the future price direction.
Here’s what the price interaction signals:
While the objectiveness of MA makes it accurate, it shouldn’t be treated as an ultimate or self-confirming indicator.
Remember, you should always employ multi-indicator analysis as the financial markets are overly complex and dynamic.
Here are the two indicators that boost and complement the effectiveness of moving averages:
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