Strike 3.0 consists of two complete trading strategies, including entries, targets, stop losses, sizes and trade management for each strategy. A significant element of these strategies is Support and Resistance levels for entries and exits. Support and Resistance levels are prices at which the trader can expect the price to react in some way. Most commonly they consist of moving averages, daily and weekly pivots, psychological levels, Fibonacci retracement and extension levels, key weekly and daily price levels and much more.
Support and Resistance Levels Are Self-fulfilling Prophecies
Support and Resistance levels are like self-fulfilling prophecies. A trader identifies a level at which he believes the price will react (reverse or breakthrough.) He places orders at that level in expectation of a price reaction. Many other traders also think the price will respond a particular way at that level and they act accordingly. Pretty soon you have a preponderance of traders expecting the price to react at that level. And because this huge group of traders has acted on that belief, the price reacts the way the traders expected it to act.
The larger the group of traders that expects a support or resistance level to break or hold, the more likely the level will do exactly as expected. Not every level has the same number of traders (or perhaps I should say the same amount of capital) dedicated to the price reaction so that some price reactions may be smaller or larger than others. But you can usually judge the importance of a level by the way price has reacted to it in the past.
How Can I Identify A Significant Price Level?
You can start with the most obvious levels: those of the more common indicators. Moving averages, Fibonacci retracements, daily, weekly and monthly pivots, psychological levels, any number of other tools. Of these, we typically use Moving Averages, Fibonacci and psychological levels in our trading room. Be sure not to use too many, or you may end up with "Analysis Paralysis," the inability to take trades because there's always a level three pips away from your current position.
In addition to the indicators, we identify and use price action support resistance levels (for simplicity's sake, let's call these levels S/R). Price action S/R is simply the price zones at which price has reversed direction. We look for these zones on the Weekly and Daily charts and identify them with lines. These lines are just representations of zones that can be 10-20 pips wide. Remember a line is never just a line; it's always a zone.
How Do I Draw the Best Support and Resistance Indicator Lines?
To identify lines on a particular pair, we start by finding the "fractals." A fractal is a candle that protrudes above or below the two previous and two subsequent candles. You can use the Bill Williams Fractals indicator in your MT4 platform to help you find them. Draw a horizontal line at a nearby fractal. It may not be the nearest fractal to the left of the current candle, but it should be near the current price level. Then look to the left along the line and see how often price "respected" the line. In other words, this particular price level has been significant in the past.
Since it's not just a line, a price may not quite reach the line or may push through the line, and we still consider that the line was respected. The line can also be recognized when a candle body touches the line as well. There can be instances where the line was passed through, but prior and subsequent candles beside the pass-through candle may have respected the line. If your line is well respected, you've chosen a good line. Typically, we will initially draw a couple of weekly lines and a couple of daily lines on either side of the price. You may want to color-code your lines, so you know which are weekly (more relevant) and which are daily (less important.)
How Do I Use Support And Resistance Lines?
In the Strike 3.0 Reversal Strategy, we use S/R Lines for our "line in the sand" on reversals. Once we've identified a pair for reversal and we have Strike 3.0 Reversal signals, we will look for a nearby S/R line to place our order. Typically we'll put it five pips ahead of the S/R line (5 pips above for a significant reversal, five pips below for a short reversal.) We try to pick a critical S/R line (preferably a weekly line) at which price would have a strong rejection. We will also use Fibonacci levels, Pivots or Psychological levels (levels whose price ends in zero) for use in finding targets for our reversal trades.
In the Strike 3.0 Momentum Strategy, after we get our Momentum Signal, we set a limit order ahead of the 20 periods Simple Moving Average for a pullback entry. We have an initial target but will adjust the objective ahead of an S/R line. This is a summary of how to calculate forex support and resistance zones.
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