Lesson 3: Round Numbers Have you ever wondered why prices tend to stall at certain levels in the stock or 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 stock or 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. Stock Psychological and Round Levels 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. Stock 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. 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 e.g. 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. #Round Numbers – example Let’s walk through a simple example: If someone were to ask you how much you spent on your computer, you would likely respond with an amount rounded to the nearest hundred (about $800,’ or ‘I paid $900.’) Sure, you can give an exact answer like $639.96, but that doesn’t really make any sense. If I had asked the question, I probably don’t 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 AUD/USD currency pair place a stop at an even 1.0000; not imagining that the price might come into play shortly thereafter. 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-Zero’s’ on the current EUR/USD chart.
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 EUR/USD or 131.50 on GBP/JPY 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: 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 let’s look at the same chart, with some of these swings identified:
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 trader’s 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. Let’s 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, I’ve marked 3 strong inflections off of the 1.3000 neighborhood:
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 that is way too cheap 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.