Psychology Of Support And Resistance And How Role Reversal Happens In Forex

Psychology Of Support And Resistance And How Role Reversal Happens In Forex   

The concepts of support and resistance can help a trader know about the market direction, track entry positions, and establish profit and loss exit points. Thus, they play an effective role in risk management and making timely decisions.

Although the concept of role reversal is not frequently mentioned, you need to be well aware of this for building your trading plan. Support occurs when there is a lot of buying activity, thus, a downward trend is likely to stall. Also, resistance occurs when there is a lot of selling interest, thus, an upward trend can momentarily halt.

Want to know all about the psychology of support and resistance and how role reversal happens? Let’s get right into it!

Everything About Support And Resistance

If you are a trader, you may have heard something like:  “broken support level will become a future area of resistance” or that a “previous level of resistance will become a support.” When it comes to technical analysis, support, and resistance levels are two fundamental terms to comprehend.

These levels are used on a price chart which limits the market’s range of movement. Support level means the point when the price level stops falling and goes back up. On the contrary, resistance level means where an upward trend reverses when selling pressure becomes more intense.

To simplify this, these terms are the indicator of supply and demand. When there are more buyers, the price could rise and when there are more sellers than buyers, the price will fall.

Support prevents prices from falling any lower by acting as a floor. When a currency pair reaches a support level, traders usually see it as a good time to purchase. So they join the market, which causes demand and could lead to a price increase.

On the other hand, traders see a chance to sell at resistance levels, thinking the currency pair is too expensive. As a result, they liquidate their current holdings, creating selling pressure that could lead to a decline in prices.

Here are some key points to understand about support and resistance:

  • Role Reversal

Sometimes, a price may break through a support level and change to a new resistance level. The opposite also happens often. Thus, the name for this change is “role reversals.” For example, if the price drops below a level that was once support, it might face selling pressure when it tries to go back up to that level, which is now resistance.

  • Strength Of Levels

Not all support and resistance levels are equally strong. Strong levels are those that have been tested multiple times and have caused significant price reactions. Weaker levels may be easily broken.

The levels of support and resistance are not all the same strength. If a level creates significant price changes, that can be identified as a strong level.

Traders often pay more attention to these levels because they are more likely to stay in place even when the market drops. On the other hand, lower levels may be easy to break through.

  • Psychological Levels

One of the most important things that determines support and resistance levels is psychological levels. Round numbers or psychologically significant price levels, like those that end in.00 or 50, are often used to draw important support and resistance levels.

  • Trendlines

Traders often use trendlines to connect support and resistance points. Thus, they can see and understand where price charts show support and resistance levels. The trendlines are made by connecting important points of support or resistance over time.

  • Breakouts

Significant price movements due to a price’s breakthrough of a support or resistance level are known as breakouts.  Traders are always on the lookout for breakouts because they can mean the start of a new trend or the continuation of an old one.

How Do Role Reversals Happen In Trading?

When broken price levels either due to support or resistance can stop the price from returning to the pre-breakout levels, it is known as role reversals. This is a good way for momentum investing when the market is going up. Thus, this helps traders to enter stocks that are already moving in a direction that is likely to go up.

Using the role reversal, you can make the best use of the financial market’s upward trend and join its upward price movement. If you can spot a role reversal, it gives you an amazing opportunity to change your strategies accordingly. Thus, the chances of gaining more profit open the door.

Role Reversal patterns will show the following price movement features:

  • The occurrence of an initial major breakout with above-average volume
  • The price level pulls back and retraces from its recent highs
  • The earlier resistance level, which is now a support level, is where the pullback ends. Then, the price returns to the previous resistance level
  • After the price bounced off of the previous resistance (now support) level, it made a higher high candle, leading to another breakout

How To Identify Support And Resistance Level?

Spotting support and resistance levels can be easy if you look at a few things. To identify support and resistance levels, you can look at:

Previous Price Data

Price data from the past is one of the best and most accurate ways to find support and resistance levels. You need to recognize past patterns and price points.

Thus, if you study how prices have moved in the past, you can understand the buying and selling pressures. However, sometimes it may be unreliable due to the different market circumstances.

Past Support And Resistance Levels

By thorough research, you can use previous support and resistance to figure out when to enter and leave a trade position. Traders often find these levels by looking at price history to see where the market tends to stop moving or turn. This might not give you the same price, but you will get a clear enough idea for your prediction.

Technical Indicators

Technical indicators or trendlines show where support and resistance levels change as the market does. Traders can find possible price barriers through analysis, calculations, and visual patterns. However, this requires you to be an expert at using technical indicators to find appropriate support and resistance levels.

What Is The Psychology Behind Support And Resistance?

You will see different types of psychology behind support and resistance. Here are a few common ones that we’ve found:

Long Traders

As the price rises from a support level, long traders wait until the price rises again. They are the hopeful ones who wait for the price to get back to the same support level, and add to their investments.

Short Traders

Short traders want prices to go down. That’s why, when prices rise from a support level, they start to doubt their holdings. They might choose to buy to get out of the trade close to breakeven if the price goes back to the support level.

Neutral Traders

Traders who haven’t joined the market yet watch how prices move at support levels. If the price goes back to the support level, they may be ready to go long. Thus, they get ready to get into the market at this point, which makes the support level stronger.

Collective Market Memory

Support and resistance levels are not made up on the spot. They are made up based on the participant’s previous experience. Thus, the traders remember previous price levels in the financial market and trade accordingly.

This shared memory affects traders’ choices when prices are close to support or resistance levels. Thus, this makes the levels more important for making buying decisions and affecting price changes.

Fear And Greed

These are basic feelings that have a big effect on how people operate in the market. If a price falls down to the support level, some take out their investments and gain from the fear that the price may further go down. But in the case of the resistance level, some traders tend to sell due to their greed and take gains or start short positions.

Stop Loss Orders

These orders are meant to limit possible losses. Thus, traders often place these orders around support and resistance levels as they think prices might change. People in the market are aware of how many stop-loss orders there are. Thus, they may set the orders to stop losses during price changes. This is called “stop hunting.”

Market Psychology

Traders see support and resistance levels as mental walls. They may affect trading decisions and choices. For example, when the price goes above a level of resistance, some buyers may be afraid they will miss out on more gains.

On the other hand, when prices drop more than the support level, retail traders may be fearful and start selling.

Common Pitfalls To Avoid

Trading on support and resistance reversals can be rewarding but it also requires your attention in a few areas. If you remain steer clear of some common pitfalls, you will be more likely to succeed in this scenario.

Overtrading

One common mistake people make when trading support and resistance reversals is trading too much. Greed may drive people to trade more which may bring significant losses if you’re not careful. Overtrading occurs when people don’t want to miss out on chances or they want to make money quickly.

On the other hand, buying too much often results in higher transaction costs. Also, you will get mental exhaustion, stress, and lower total profits as a gift. Thus, professionals suggest focusing on quality over quantity, while practicing patience while trading.

Ignoring Fundamental Analysis

Technical analysis is a vital step to make your trades successful. Unexpected market moves can be caused by economic data releases, global events, or big company news.

If you don’t pay attention to these and analyze the situation, you can never use support and resistance levels properly. This will make you miss out on profits and lose money if you’re not careful enough.

Ignoring Risk Management

This is a big mistake that can happen with any trading plan. Trading support and resistance reversals come with risks. Thus, you need to prepare adequate risk management strategies to cope with them.

That’s why you need to set clear risk limits, like using stop-loss orders and figuring out trade sizes based on how much risk they are willing to take and the size of their account.

Wrapping Up

Understanding role reversals can help you gain a lot of profits from trading and utilize your strategies effectively. Thus, it’s important to hone your tools and get to trading when you know all the trends and tactics.

Resharpen your strategies and be aware of the ongoing changes when you are vouching for support and resistance levels.

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