Trading psychological whole numbers




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Trading psychological whole numbersTrading Psychological Whole Numbers

There are many different ways of looking at support and resistance, with few as compelling as the study of ‘psychological whole numbers.

If youve been trading on charts for long enough, youve surely noticed the odd behavior that prices will have a tendency to exhibit when a ‘round number (prices such as .9900 or .9800 on AUDUSD) is seen. Below is a picture of the Aussie-Dollars recent struggle to get over the ‘parity level.

Created with Marketscope/Trading Station

As you may know, parity is the price of 1.0000 on AUDUSD; or to put it another way this is when One Australian Dollar is worth One US Dollar.

Things get weird at this exchange rate.

As human beings, we have a tendency to value simplicity, and our own internal psychology plays a large role with the odd price behaviors that may be exhibited at these ‘psychological levels.

Lets walk through a simple example:

If someone were to ask you how much you spent on your computer, youd likely respond with an amount rounded to the nearest hundred (‘ah, about $800, or ‘I paid $900.) Sure, you can give an exact answer like Six-hundred-and-thirty-nine dollars and ninety-six cents; but that doesnt really make any sense. If I had asked the question, I probably dont care about the $39.96; I just wanted a ballpark idea for how much you paid for the computer.

Out of simplicity, most people (most of the time) will automatically round to the nearest whole number.

This happens in trading too.

Traders looking to sell the AUDUSD currency pair place a stop at an even 1.0000; not imagining that the price might come into play shortly thereafter.

What are the whole numbers?

Traders will often call these whole number intervals ‘double-zeros, as these prices are at even numbers such as 1.31000 on EURUSD, 1.57000 on GBPUSD or 132.00 on GBPJPY. The chart below will identify the ‘Double-Zeros on the current EURUSD chart.

Created with Marketscope/Trading Station

Some traders will even take this a step further by looking at the number directly in the middle of these whole numbers or ‘the fifties. These levels, such as 1.31500 on EURUSD or 131.50 on GBPJPY can often come into play in the same manner as the ‘double-zeros.

One look at any chart will notice that there will often be some element of congestion at these levels as prices move up or down. The chart below illustrates EURUSD with ‘double-zeros and ‘fifties denoted:

Created with Marketscope/Trading Station

Notice that many of the price swings on the above chart take place around one of these levels. This is why we want to incorporate these levels into our support and resistance studies.

Now lets look at the same chart, with some of these swings identified:

Created with Marketscope/Trading Station

This is why these prices can work so well as support and resistance. Because people (traders) watch, and care about these prices. Not every one of these prices are going to function as support or resistance, but enough do that these levels warrant the traders attention.

Why do Psychological Levels Work?

Psychological Support and Resistance often works because of the very fact that we looked at to start this article. As human beings, we value simplicity; we think in whole numbers and often, when placing stops or limits, we use these prices.

These stops and limits can massively alter order flow and price changes. Lets use the EURUSD as a current example, as price recently made a large move down around the news and events of the European Debt Crisis. On the chart below, Ive marked 3 strong inflections off of the 1.3000 neighborhood:

Created with Marketscope/Trading Station

Each time price approached 1.3000, the currency pair bounced back up. This can be explained for a few reasons.

Perhaps traders saw the price of 1.3000 and thought ‘whoa, that is way too cheap. Im going to buy some Euros.

Or, more likely, as traders were opening short positions, they set profit targets at an even 1.3000, so that when that price was hit they had a pending order to ‘buy to cover. This profit target order to close their position created demand in the market (they were buying to cover, and this buying interest is considered ‘demand).

After the first inflection, traders may not have been extremely bullish on the prospect of pushing price much lower than 1.3000. After all, this price has already been exhibited as support.

In many ways, untested ‘psychological levels can be looked at like pivot points. An area where there may be some element of support or resistance, but unfortunately it is impossible to tell until after the fact.

In general, round numbers such as 1.30000 on EURUSD or 1.0000 on AUDUSD or USDCAD will garner more attention than a more pedestrian level like 1.31000 on EURUSD; so many traders will often assign a higher degree of strength to the more rounded-intervals.

Where traders can really find value with these levels is when prices may have resisted or been supported there in the past. This tells the trader that others are noticing and acting on those prices, and the potential for the ‘self-fulfilling prophecy of technical analysis may potentially be considered with more strength.

--- Written by James B. Stanley

To contact James Stanley, please email InstructorDailyFX. You can follow James on Twitter JStanleyFX.

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