A lot of traders are using forex as a trading system, but most of them don’t know how to find the key levels in forex.
One of the most important aspects of trading is finding good trading setups. This is how you can determine when a stock or forex is in a good trading position.
In this post, we’ll show you how to find the key levels in forex and how to use them in your trading to your advantage.
What are Key Levels?
In Forex, key levels are the point where the price of a currency pair goes on an uptrend or a downtrend. While the untrained eye will find it hard to spot the exact point of key levels, trained traders who understand the dynamics of the market and how candlestick develop can accurately pinpoint where price makes a crucial turn. Understanding how to spot key levels is a practice you have to learn if you want to exploit the market for gains. Levels also help you to know at which point to open trades and whether the market will become bullish or bearish.
In a real trading situation, traders do a lot of technical analysis before making a decision. As we proceed in this article, you will understand the dynamics behind key levels and why it is so important in forex trading.
How do traders draw key levels?
There are two types of key levels, and they are commonly called support and resistance levels or zones. When analyzing a currency pair, traders draw the support and resistance lines to indicate their zones. More than just lines, these zones are very significant. Get it right, and you may likely end up with a winning trade; get it wrong, and you may suffer losses. Support and resistance helps traders to make three basic price projections, namely,
- Establishing when to exit the market at a favorable or unfavourable price
- Know the direction of the market
- Time their market entry perfectly
But what are support and resistance levels?
What is the Support Zone/Level in Forex
In forex, the support zone is an area or region in a trading chart that shows the point where the price of a currency pair has dropped but is unable to break through. Basically, this trading theory suggests that the number of buyers in the market for the currency pair is significant and willing to buy more of it, to the point that the price will not drop below a certain level. Also, if at all, it drops to that level or point, it bounces back up again as more buyers exert their influence in the market. Another way to look at support is that as the price drops, more buyers see an opportunity to make a profit, so they buy more of the asset, and their actions reverse the drop.
In the same vein, holders of the currency pair are refusing to sell because they believe that the price will climb further for them to sell at a higher price. So, this point of price reversal is what is called support in forex trading. It basically refers to a level that price will not drop below.
What is Resistance is the Resistance Zone/Level in Forex
Resistance is just like the direct opposite of Support. On a trading chart, Resistance refers to the point that price has struggled to break through after going on an upward trend. On a trading chart, the price of a currency pair may continue to rise, but it never rises above a certain point. When viewed in 5 minutes or even a one-hour timeframe, it never rises above that point. Just like Support, this level or point represents an invisible barrier on an uptrend that is classified as Resistance.
The explanation for this trading phenomenon is quite simple. The Resistance level is the price level at which the actions of sellers in the market causes the price to drop because there are more sellers for the currency pair than buyers. As buyers push the price up, it gets to a level where it becomes too expensive for many of them to buy, and so sellers begin to exert their authority by selling to make a profit. In this scenario, the sellers become too strong for the buyers, and so, price drops.
So Support is like a price foundation that prevents a downward trend from going any lower; Resistance is a barrier that prevents an upward trend from going any higher.
Effective Support and Resistance Trading Strategies
Key levels in forex are mainly the critical point of price movement, and these points are interpreted by Support and Resistance zones. Without a clear identification of these zones, finding key levels in forex trading is virtually impossible. Here are effective Support and Resistance trading strategies you can adopt.
Range Trading
One effective strategy for using Support and Resistance is what is called range trading. This method seeks to establish the space between both zones as traders decide when to buy or sell. Ranging traders are very good at trading in consolidated markets where a trend is harder to establish. So rather than waiting for a strong trend to develop, they simply trade in between the space left on the charts between Support and Resistance. Also, it is important to note that in a ranging market, the price may likely break out, but this breakout may either be a real or a false breakout.
If you must adopt this strategy, it is vital that you use stop loss to hedge against risks.
Pullback/Breakout Strategy
This is another Support and Resistance strategy many pro traders use. This strategy is very effective in erratic markets where price movement is almost impossible to determine. The trader who uses the pullback strategy look for breakouts below the Support Zone or above the Resistance Zone. The idea is to exploit a breakout if one occurs because they believe that if the breakout is strong enough, it may likely start a new trend.
However, expert traders are not always in a hurry to open trades when a breakout occurs the first time. Rather, they wait to see if the price pullbacks and breakout a second time. If it does, they consider it an indication of a strong momentum that will continue this trend in the same direction as the breakout.
Trendline
Trending strategy is an age-old strategy that involves the drawing of trend lines to indicate the support and resistance points. The drawn line connects two or more lows or highs depending on the market situation. So once the price breaks through the line, trendline traders make trading decisions based on the new trend that has been formed regardless of whether it is an uptrend or a downtrend.
Moving Average
A moving average indicator can be used in place of support or resistance, and the average varies depending on the trading habit of the trader. Popular averages like 20 or 50 are common, but some traders alter theirs to reflect the 21 and 55 periods. What moving average does is to track price above the resistance line with an expectation that the market will reverse itself to become a support level. Using moving average requires a lot of technical skills, so we recommend you master it in demo trading before you use it in your live account.
Types of Resistance & Support Levels
These levels are represented in trading charts in multiple ways, but there are some common types which we review below.
Horizontal Key Level Chart
This chart shows support and resistance by placing their levels at the top of a previous upward trend or the bottom of a previous downward trend. These charts then project future price movement by signifying the key level where the market will reverse.
Non-Horizontal Key Level Chart
Support and Resistance Levels are represented in a non-horizontal Key level chart by trend lines that are not horizontal but still indicate the crucial point of price reversal. These lines are simply used to spot trend lines and determine the direction of the market.
Round Number
This pattern relies squarely on round number exchange rates which is commonly the 1.00 parity exchange rate. Users of round number patterns prefer to open trades in round-number levels, so this becomes their support and resistance level rather than just trend lines.
Dynamic Key Chart
Another method many traders use is a dynamic key chart. This key chart shows changes in direction when price changes. This key chart is found in most trading platforms using indicators like pivot points and moving averages.
How to find Key Levels in Forex
Having explained the dynamic relationship between key levels and support/resistance, it is imperative we now address how to find key levels on a trading chart.
The general practice of many professional traders is to use Trend lines and channels. These tools are found in almost all trading platforms, and they are essential tools for conducting technical analysis. With channels and trend lines, you can identify the point at which a market becomes an uptrend or a downtrend. These tools are effective because
- They help you discover the trend on time so you can open trades and exploit the trend as much as possible before it reverses.
- They help you make accurate decisions on where to place your stop loss
Trends and channels are not effective in shorter timeframes, though. For shorter timeframes like 1 minute or 5 minutes, it is very difficult to use them effectively because of price swings but more effective for longer timeframes. Using them in longer timeframes like 30 minutes and above give you a clear idea of the general market outlook for a particular trading day.
Note: If you prefer the easy way, there are integrated tools developed by platform developers to help you pinpoint key levels in Forex. Do your own research to identify a tool that works best for you.
How to trade key levels
Due to the dynamics of forex trading as a practice, many traders have their own methods of trading key levels. For the purpose of this article, we give you some of the popular methods used by many in the industry.
Breakout
Breakout trading is very simple. A breakout trader watches for price breakouts beyond a key level to open a trade. This type of trader believes that once a breakout occurs and is established, it will continue that way for a very long time. Therefore, before making their move, they wait to see if the breakout is a false breakout. If it is, the candle will break through the key level, then pull back and not return. If it is not a false breakout, it will break the key level, pull back, then break it once again and continue the new trend.
Approach
Traders who use this method wait for the price to retest the key level several times until it is broken. So when the price is approaching a key level, they make their move before it gets there. This method is very risky and only recommended for more experienced traders.
Bounce
Another trading method is to use Bounce. This method is very simple. The trader patiently waits for the currency pair’s price to enter the support zone before buying because he expects the price to bounce off the zone or sell once it enters the resistance zone because he expects a bounce or a pullback.
Caveats when trading with key levels
Trading with key levels carries risks, so as a trader, you want to be very careful. Here are some things to bear in mind when trading with key levels.
Timeframe
Be mindful of the timeframe you use. To be successful at key level trading, avoid shorter timeframes. Rather look for key levels in longer timeframes like 4 hours or 24 hours timeframes to give you a fair idea about price movement.
Avoid opening multiple trades
Unless you are 100% sure of your analysis, keep your trades open for only a single window. Also, keep it open for as long as the pattern continues and exit it once it reaches your target profit point or stop loss point.
Practice good risk management
Make the best use of stop loss and lot sizes. With stop-loss, you can limit your risks if your analysis is wrong, as is common with forex trading. Another way to practice efficient risk management is to use price alerts to keep you in the loop, so you know when the price goes against you. Nothing is ever certain in the forex market, and experts know this. This is why they practise effective risk management techniques to hedge against risk.
Note: Try not to place your stop loss too close to your key level; otherwise, you may exit a trade prematurely when there is still potential for a win
Be patient
You will not always enter the market at an accurate key level but fear not. If you miss it, be patient and wait for a pullback, as is often the case to get back into the trade. If you are a breakout trader, don’t jump right in at the first sign of a breakout, rather wait for a pullback and then another breakout to be sure that it is not a false breakout.
It is not a competition
Forex trading is not a competition so avoid treating it as such. Please rely on the trend and never go against it. If the market goes against your indicators and analysis, do not trade on hope. It pays to wait for favorable conditions before entering the market than to risk it and suffer losses.
Conclusion
Forex trading involves many techniques and trading strategies, and key level identification is one of them. If you can ascertain key levels with a degree of accuracy, you will be best placed to know when to enter and exit the market.