We know classic support and resistance forms where price has seen a reaction somewhere in the past, but traders want to look forward for EXPECTED support/resistance. Traders use forward looking support/resistance targets such as pivot points, average daily ranges or even fib extensions to get their fix. However, the most obvious of all is just a simple round number!
With the Aussie Dollar at a key psychological level, I thought it would be a good chance to take a look at why markets react at psychological round numbers. Anything with an 00 on the end grabs attention. It’s simple human nature for us to be drawn into round numbers like this.
This is because as humans, we value simplicity. Psychological round numbers work as support/resistance because we think they work. It’s a self fulfilling prophecy. Because we think they work, traders will place their stops and limit orders on either side of them, causing price to continue reacting and keeping the cycle of fulfillment alive. When order flow is altered in this way, price is going to react.
As a simple test oh the human psych effect to round numbers, ask someone how much they paid for their lunch today. If it was $4.99, then most likely they will round it up to $5.00 without even thinking.
Take a look at the Aussie Dollar today:
The 80c resistance level has been tested, stops were cleared through it, the daily candle closed below the level and price is now heading back down. Yes, the psychological round number level has once again been respected.
Being based in Australia, the Aussie Dollar has added significance for me personally. Every finance section of news reports lead with AUD/USD and the 80c level is ALWAYS mentioned.
“The Aussie Dollar is back below the 80c US mark…”
As you can see on the AUD/USD chart above, it’s all just self fulfilling.
I encourage you to watch for round numbers and how price reacts to them. You’ll be surprised just how much markets are a reflection of human idiosyncrasies.
Best of probabilities to you!
Dane Williams – @VantageFX
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Source: Vantage FX Blog