The Psychology Behind Round Numbers and Support Resistance Levels in FX Trading
Have you ever wondered why prices tend to stall at certain levels in the forex market? Is this just a coincidence or is there a valid reason behind this happening? Well, this phenomenon may actually be explained based on the psychology of forex traders.
As humans, we tend to think in terms of whole, round numbers rather than in terms of uneven random numbers. This happens very regularly in everyday life where numbers tend to be rounded up or down in order to simplify things.
For example, if someone asked you the time and you looked at your watch and it was 12:29pm, what time would you give the person? Based on the psychology of rounding, many persons are likely to just say 12:30pm rather than 12:29pm since 12:30pm is a rounded number and 12:29 is not.
Or what if you wanted to know the price of a meal and saw that it was advertised for $9.99? In your mind, you would probably round it up to $10 instead of $9.99. A similar thing happens in trading when traders conduct technical analysis by examining the price charts.
Forex Trading and Round Numbers
By default, most traders have a tendency to prefer rounded currency values to odd, random values. Because of this psychology, areas of support and resistance tend to form around certain price levels since traders subconsciously tend to place stops and take profits at areas where price is rounded. For example, a trader is more likely to place a stop at the 1.2500 level than at the 1.2502 level.
Double Zeros, Increments of 500 and 100
In forex trading, rounded prices usually are regarded as those prices in which there are double zeroes (or more) at the end of the price eg. 1.3400 or 1.5000. Usually the more zeroes at the end of the price, the stronger psychological level and barrier. In addition, short-term intraday traders also view half way points and price points that are multiples of 100 to be rounded.
If you were to study any price chart, you would find that areas of resistance and support usually form at these price levels. Price swings tend to take place at these resistance and support levels.
Once the price crosses these invisible barriers, the price changes from being a level of support to being a level of resistance or from being a level of resistance to a level of support. Traders often use these signals as an indication of what is likely to happen once price approaches these psychological levels.
If price tended to stall at these levels when prices were going up, then chances are great that they will stall at that same price, should the price reverse and fall. The chart below shows an area of important support turned into an area of resistance once the price breaks below the support level.
How Support and Resistance Psychology Can Improve Your Trading Success Rate
Support and resistance levels tend to hold true until or unless there is a breakout. Therefore, traders can use these levels to predict how prices are likely to move with a high degree of accuracy.
In addition, these levels help traders to establish where they should naturally place their stop loss and take profit orders. A stop loss order is usually placed a few pips below a level of support or a few pips above a level of resistance. Or a profit target order is usually placed a few pips below a level of resistance or a few pips above a level of supports. Since most traders tend to trade this way, you will find that price action tends to follow these patterns very closely.
For some traders, the first thing that they do when deciding how to trade, is to draw in major lines of support and major lines of resistance. These lines act as guides to help the trader determine the most likely direction that the market will take. In many cases, these “prophecies” tend to become self-fulfilled.
The concept of Fibonacci levels is based on the psychology of support and resistance levels. It has been found that if a trend reverses, that prices will tend to stall at certain psychologically determined (Fibonnaci) levels. Prices tend to retrace to one of several points that are set distances from a price range at which the Fibonacci is applied. The following chart shows Fibonacci levels and how price action tends to react after reaching these levels.
These Fibonacci levels tend to be at or near rounded prices. For more information about Fibonacci levels, visit our educational article called " How Fibonacci Retracement is Used in Forex Trading ".
Traders value simplicity and therefore tend to push prices towards areas where prices are rounded. This creates areas of resistance and areas of support at which prices tend to stall. Prices will continue to stall at these prices unless there is a breakout and the market sentiment changes.
In such an event, a previous support level would become a resistance level and a previous resistance level would become a support level.
These levels of support and resistance can help traders to more accurately predict the movement of prices. This means that resistance and support can actually help traders to earn more profits and to make better trading decisions.