What Makes Support and Resistance Work Correctly

1) A level of support can act as key psychological price marker for traders to place their buy orders or get into a position with the market often acting as a collective. The psychology of the “fear of missing the boat” can often help a position bounce from the level of support.

2) The Central bank often pegs currency at key support levels to help maintain their domestic currency price, so as to further the nation’s financial/domestic interests.

3) Market depth of buy orders is huge at or below zone of support.

4) Psychological level for sellers to cover (and hence buying orders increase due to covering).

5) Price becomes more attractive to buy than to sell. Demand greater than supply.

6) All big players and SM use support and resistance to trade. This is significant enough in the sense of their volume and position size being capable of making a “presumed” support become an actual support. Similar to central bank currency pegging concept.

What Causes Support and Resistance to Fail

3_Forex_Trading_Buzz1) Market depth of buy orders is considerably weaker than previous support points. Here if the position pushes through the support a flurry of stop-loss sell orders will be hit, further pushing the price down.

2) People who missed the breakout would like to now short at a better price, when the price returns back to the original support level which then turns into resistance.

3) Prices bouncing of previous support are tapering, not going higher highs, but lower highs. A form of divergence or weakness in the support bounce. Psychologically, traders see such bounce as being weaker and less emphasis is given to such support levels, resulting in shallower market depth of buy orders.

And the list is not exhaustive. The key point is that the market is a psychological entity, rather than a rational body which dictates that the price reflects an efficient market. Greed, fear, conservatism all exist in the market, and they are reflected in price action.

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