Advanced Stock Market Trading - Level 1_3. Round Numbers

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.
A​ s 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
F​ or 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. O​ r 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
B​ y 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.

I​n 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.