The Concept of Dynamic Support and Resistance Levels
The previous article here on the Forex Trading Academy dealt with classical support and resistance levels, and how to use these levels to trade the Forex market. We showed plenty of examples based on the EUR/USD daily chart, with the purpose of making it simple to understand the concept. While classical support and resistance levels are widely known, there’s another concept even more powerful: dynamic support and resistance. Such a concept offers turning points that are most of the time tops or bottoms in major trends, and traders need to have an open mind when looking for them.
Dynamic Support and Resistance
If classical support and resistance levels form on the horizontal, dynamic ones do not. This is the biggest difference between the two concepts: dynamic levels are not horizontal ones. The overall concept is not an easy one to grasp, in the sense that the market may still make multiple highs (in a bullish trend) while still being at dynamic support. The same is true in a bearish market, where the market, while at dynamic resistance, can still make a series of lower lows.
Identifying Dynamic Support and Resistance Levels
Identifying such levels should be an easy task, in the sense that they are associated with the channelling concept. The perfect example can be shown using a Pitchfork (please refer to the articles dedicated to trading the market using the Andrew’s Pitchfork), as the result will be two parallel channels. At the upper part of the channel, the market will meet resistance, while at the lower part it will meet support. Because the channel is not horizontal (it will either rise or fall), the support or resistance is called dynamic, and not classic. To illustrate such a concept, the chart below shows the EUR/USD pair on the daily chart, the same chart and timeframe used in the Classical Support and Resistance article. The idea behind this is to show that trades can be taken using both concepts on the same chart.
Looking at the chart above, we can see the price dropping like a rock on the back of the European Central Bank (ECB) cutting the rates into negative territory; and then from the 1.05 area a bounce happens. Using the principle of a Pitchfork, we cannot draw the Pitchfork until we can identify the three pivot points. After the pivots are identified, the Pitchfork can be drawn and the three lines will form the two channels mentioned earlier. In this case, the three pivot points are the following:
- The first one is given by the low the market made.
- The second one is the maximum high when the price attempted the recovery.
- The last pivot that gives us the Pitchfork is the marginal low (higher low) that follows the second pivot.
Applying the Andrew’s Pitchfork tool will show the chart above with the two channels that move to the upside. In this case, all three lines of the channel represent dynamic support and resistance levels. The usual caveat when dealing with support and resistance is to be applied here as well: By the time a level is cleared, it will transform into the opposite one. This means that support will turn into resistance, and resistance into support after the levels are broken. Furthermore, the longer the timeframe is, the more powerful and difficult it is to break the levels. In this instance, this daily timeframe is long enough to offer important support/resistance levels every time the price meets the trendlines. It is important to note here that these levels that are derived from the Pitchfork refer only to dynamic support and resistance identified after the Pitchfork could be plotted, meaning after the third pivot. For a clear understanding, the vertical line in the chart below explains why we should only look for the levels on the right side of the vertical line.
From the moment that the Pitchfork can be drawn, the price moves sideways while still making a series of higher highs. However, in doing that, it is failing to reach the upper side of the channel. If it had reached that area, that would have been a dynamic resistance, and short trades would have been recommended. As you can see, the more time passes, the higher the dynamic resistance level will be, as the channel is a rising one. Moving forward, the price meets dynamic support three times on the lower part of the channel, until finally the area is cleared. From this moment on, support turns into resistance; but because the level is dynamic and not a horizontal one, the dynamic resistance turns out to be higher than the support resistance. Nevertheless, it is a resistance that the price meets, and shorting the pair, or at least closing the previous long trades, is recommended.
Using an Oscillator to Trade Dynamic Support and Resistance
Like in the case of classical support and resistance, trading dynamic ones can be successfully done with the help of an oscillator. Using the same oscillator as in the previous article is recommended, only to see exactly how things differ. For the classical support and resistance levels, we used the standard method to interpret the Relative Strength Index (RSI), in the sense that overbought and oversold levels are sufficient for seeing where to sell or buy. This is how a classical, horizontal range should be traded. When it comes to dynamic support and resistance, things are a bit more complicated, in the sense that the horizontal does not offer any value. In view of this, the RSI should be used differently, and this is where divergences intervene. The thing to do is to look for a divergence between the oscillator and the dynamic levels to find out which one is lying. As a rule of thumb, always stay with the oscillator, as it considers more periods before plotting a value. In this case, the RSI considers 14 days before plotting a value.
The chart above shows the RSI in a clear divergent mode when compared with the dynamic support levels, and it suggests it is a mere moment in time until price will overcome the support. On a break, the lower base of the Pitchfork becomes resistance, and traders should look to sell by the time the price reaches that area. There are multiple ways to interpret dynamic support and resistance levels, and the Pitchfork is only one of them. Classical channelling is a tool that can be used as well, and an oscillator always comes in handy for great results when trading the Forex market with such a concept.
Other educational materials
- How to Use Parabolic SAR to Buy Dips or Sell Spikes
- A Guide for Trading Rising and Falling Wedges
- How to Draw a Trendline
- Pennants as Continuation Patterns
- Price and Time – The Holy Grail in Trading
- How to Set Up an Expert Advisor
Recommended further readings
- New Perspective on FX Markets: Order‐Flow Analysis. Lyons, R. K. (2001). International Finance, 4(2), 303-320.
- The economic value of fundamental and technical information in emerging currency markets. De Zwart, G., Markwat, T., Swinkels, L., & van Dijk, D. (2009). Journal of International Money and Finance, 28(4), 581-604.