Support-Resistance Levels: Trend Lines, Horizontal Lines and Fibonacci Retracement
By understanding Support-Resistance (S/R) and how to draw accurate Trend Lines, Horizontal Lines and Fibonacci Retracement Levels, the trader has then (in my opinion) taken one of the most important steps in learning successful Forex trading.
It’s a crucial part which should improve his trading edge and with it… improve his odds of finding profitable trades, as it’s at important S/R levels trading opportunities can show up.
So how can we locate these S/R levels?
Well, below is a list of techniques which will be covered in this course:
(You can also find these S/R Articles on my Blog in the Forex Technical Analysis Category)
– Trend Lines
– Horizontal Lines
– Fibonacci Retracement
– Swing Highs/Lows (see Horizontal Lines article)
– Moving Averages (MA’s)
– Murrey Math Lines (MML’s)
These are common methods used by traders, the choice depends on his/hers trading style, system ideas, likes and dislikes and what works for the individual trader.
That’s why i’ll cover various methods here, although using only Horizontal Lines (Level Lines) should work well to find the most accurate and strongest S/R levels and with it… find good trading opportunities over time, in my opinion.
As time goes by, only you can conclude what type works best for you, as we all have unique trading personalities.
Important, regarding S/R in general, (whatever the type written about in this section) in my view it doesn’t have much predictive power in itself.
Only when used in combination with Price Action techniques, Reversal Bars & Candlesticks, one can increase the odds of nailing a price reversal. And with it… increasing the odds of finding a profitable trade. Less important is Volume analysis and Momentum (indicators/oscillators measuring overbought/oversold market conditions)
So in short, not all types of swing highs/lows found at a Fib. level, horizontal line, trendline, etc. will give profitable trades, by using it isolated. So to be selective technically, may pay off in the long run.
The power of a simple Trend Line should not be underestimated in my view. This from my own observations and experience with it. For Trend and Swing Trading purposes this analysis tool is often more effective than many indicators out there.
Drawing trend lines on a price chart is a technique which has been around for ages among traders. They even did it on paper charts in the old times. And it’s understandable why it has survived so long, a trend line can be useful in several ways to have on a chart.
It can show the direction of an overall price trend in a more clear way. And the trend is considered intact as long as the bullish (positive) or bearish (negative) trend line holds on a Closing Price basis, in whatever trading timeframe used.
Any clear break of such a trend line (closing basis) is viewed as a hard technical signal and is a warning of a possible change in the price trend. However, false breaks can be seen from time to time but more often than not, a break like this is a valid warning about a possible change in the trend coming.
Another useful feature with trend lines, in addition to show longer term trend direction, shorter term (swing) tops and bottoms tend to form up against or at these trend lines. So these swings can offer good opportunities to make excellent market entries in the direction of the overall price trend, as indicated by the bullish or bearish trendline.
Like with Horizontal Lines, drawing a Trend Line correctly is more like an art form than a technique with fixed rules. It takes some time, effort and understanding of the markets to get a feel for it.
Trend & Price Channel
By drawing 2 trend lines on each side of price fluctuations (through the swing highs and lows) which makes up the trend, a so called trend or price Channel is established. This is another popular technical pattern used in Swing trading and for determining the overall trend direction. As long as prices oscillates higher or lower within it, the overall trend is viewed as intact.
Another benefit from using Trend lines & Channels is that a classic pattern (which gives excellent trading opportunities) often occurs when prices breaks below/above these bullish/bearish trend lines and also breakouts from channels as well (see chart example below).
After some initial price weakness, most of the time it will thereafter make a snap-back move towards the broken trend line or channel, before prices resumes on it’s new trend path. So when these trendline breaks occurs, i would follow the market development closely, until these excellent market entry setups shows up.
This often generates good Risk/Reward trades, as if prices closes i.e. into the price channel again, (proving the breakout was false) one can quickly close out the position, usually with a small stop loss.
The price target potential is much greater however, as the breakout from the channel has signaled a new trend likely underway, in the opposite direction, which the trader can cash in on. It’s an excellent approach to get in early on a new trend.
Below are chart examples of Bullish/Bearish Trend lines and Bullish/Bearish Price Channels.
How to draw a Trend line in Metatrader (Tutorial)
As shown on the figure below, click the Trend line tool button on the Menu (circled in red) and the mouse arrow should turn into a cross & pen symbol, showing it’s ready to be used.
Hover the cross over the chart to the point where you want the trend line to start and then left click and hold down the mouse button and move up and down the trend line until you’re satisfied with it’s angle, then release the left mouse button. To make a price channel on a chart, simply draw 2 trend lines in the same way.
Later if you want to adjust the trend line, simply double click it and the 3 small square boxes now showing up on the trend line can be used to adjust it in various ways. When you left click and hold down the mouse arrow on the middle box, you can move the whole trend line to any area of the chart and then release the left mouse button.
The 2 other boxes found on each side of this middle box can be used for adjusting the angle of the trend line, using the same method. When you’re finished, simply double click the trendline again and it will stick to the chart and the boxes will disappear.
When you double click the trend line so the boxes shows up and right click when the mouse arrow is placed on the trendline, pick ‘Trend line properties’ from the pop up box to change the color, thickness of the trendline etc.
If you want to delete the trend line from the chart, double click it so the boxes shows up again, right click when the mouse arrow is placed on the trendline and hit ‘Delete’ on the pop up box.
To draw Horizontal Lines with optimal accuracy on a price chart, then besides the Highs and Lows (Closing Highs/Lows included) in the market, also knowing about the Swing Highs/Lows is of importance.
Used alone they also mark Support/Resistance (S/R) points in the market. But later in this article i’ll show you how these Swings can be used in an even more powerful way for improved S/R accuracy and strength (the stronger the S/R is, the stronger the chances of causing market reversals.
Like the name reflect a swing high/low can form when prices takes a swing in the market. There are several parameters used but basically a swing high can be observed when you see a high in prices, then a higher high and then a lower high. This is also called a Pivot high by many traders.
A swing low is formed when a low is seen in prices, then a lower low, followed by a higher low. This can be confusing by just reading about it, so below is a daily EURUSD price chart with a few examples of important swing highs and lows in the EURUSD pair:
Instead of the tedious task of manually finding these swing highs/lows in currency pairs, a much quicker way to spot them is to use Bill Williams Fractals, an indicator which can easily be inserted into Metatrader price charts, as shown below:
This outputs a chart (see below) which shows many more swing highs and lows (as marked by the small grey arrows). But for drawing horizontal lines with the aim to find accurate and stronger S/R levels, in this case the more important swing highs/lows will be used only, mostly those which marks the end of significant price moves in both directions.
Next, to draw horizontal lines (level lines) on the price chart in Metatrader, left click the horizontal line button on the Menu, as circled in red below. The drawing tool is then ready, left click it one more time (hold the mouse button down) and move the line up or down until the correct swing high or low level is reached, then release the mouse button.
The below chart shows horizontal lines drawn through past swing tops and bottoms. Drawing these special lines correctly takes lots of practise as there are no fixed rules, it’s more like an art. But the trader should get a feel for it sooner or later.
The reason is partly that it’s not enough to draw the lines through exact swing highs and lows or swing Closing highs and lows found in past price history, instead it will be a mix of it, as seen below. It’s kind of averaging out all these Swing S/R levels from price history, to try come up with the most accurate future S/R level, which prices have yet to test.
One clue that the trader has plotted the line on an optimal level, is if a daily close up against it has happened in recent price history, like seen in the example below, where the EURUSD made a Swing Closing High in June (marked with red text).
Prices tried to break through this resistance intra-day but pulled back and closed up against it instead. By looking in past price history, one can see the reason why, plenty of swing high/low areas producing stiff resistance, which would be hard to overcome in future, like in June.
Once all the high probability S/R lines are drawn, to get a clearer chart view, get rid of the Fractal arrows by simply right clicking one of them and then click ‘Delete Indicator’. With more experience, the trader should be able to find these important highs and lows to plot the line at, even without using Fractals, which will save some time in preparing the charts.
The power of using these past Swings to draw the lines, is that it will weed out weaker Support/Resistance (S/R) levels and reveal the stronger ones, areas where prices are more likely to make reversals at in future and in turn produce trading opportunities with increased odds of success.
The next chart shows examples of S/R levels where prices could make reversals in the future, once those levels are reached. Exhaustion type of Candlesticks and certain Volume behavior and Momentum reversing it’s bullish/bearish mode around these S/R levels, would increase the odds of seeing a reversal.
The momentum part is not a mandatory ingredient for opening a position though, but if you happen to see it, the confidence in your market entry could be even higher. More on market entries will be covered in other parts of this course or in blog posts.
Using the same technique, those trading i.e. in the 4 hour time frame, may draw daily, weekly and even monthly Swing S/R levels on the same chart, to get even more S/R levels to take advantage of. Speaking of this, when prices are facing S/R levels and if for example a 4 hour price chart is used, it would have a harder time breaking through a daily S/R level than prices facing a 4 hour S/R level, when a daily chart is used.
Add up the Major and Cross currency pairs and there would be 28 pairs that would give many more trading opportunities throughout a trading week, using this Swing S/R technique, compared to focusing on only a few of them.
Fibonacci Retracement Levels
Fibonacci Retracement is a popular S/R tool which can also shed light on where important support/resistance levels are on a price chart. MT4 has a built in function so these levels can easily be drawn on any chart, in any time frame and in any market.
The most common retracement numbers used in trading are 38.2%, 50% and 61.8%. But some Forex traders use 27.2% and 74% as well. Reversal types of candlesticks forming at one of these levels, are more often than not a warning about the market or currency pair possibly heading in the other direction.
The below figure should illustrate this in a simplified way. If you’re looking for a Long trade in an overall bullish market, in Metatrader, simply draw the Fib. tool from an important Swing Low to an important Swing High.
All the Fib. support levels should then show up on the chart. A market pull-back towards the key Fib. support level is what many traders are looking for, before opening a Long position within a larger bullish trend. Vice Versa for a Short trade in a dominant bearish market.
The Fib. tool can be found on the Metatrader menu, circled in red.