Trading support and resistance can be a fantastic way to approach the market and for many new traders this is one of the first areas of technical analysis that they come to properly understand.
There are a great many varieties of support and resistance in the market that traders can look to build strategies around such as: Psychological levels are price levels which tend to draw big market attention and typically witness a reaction by price when tested.
Look just how many times these levels act as either support or resistance causing a reaction in price. These types of reaction are extremely common at these levels and you can see just how many reversals occurred at these levels. So what is driving the behaviour of price when it interacts with these levels and why are they so important? The main thinking as to why these levels are so important is simply to do with human nature and our general tendency for order, simplicity and reference.
This is simply down to a natural tendency to round numbers up to provide an easier reference point. Similarly, round numbers are very often used as profit targets.
If a trader is long from around 1. These psychological levels also come into play because of the big institutional and corporate interest that they attract. Many central banks have price reference ranges for their currencies which they like to see price trading in and very often when price moves to the upper or lower end of these reference ranges, we tend to see intervention by central banks, either verbal or actual. Look how many times the 1.
Price made several attempts at that level and even though on occasion it ran higher slightly, each time price reversed lower. This was clearly a key psychological level for the ECB as typically each time price traded to that level we start hearing Dovish comments from the ECB who sought to talk the currency down.
Similarly, corporates and financial institutions have a tendency to execute at whole numbers which again increases the importance of these levels and strengthens the price reactions we tend to see. As we saw on the first image there are plenty of times when price simply moves straight through them, however, these reactions are definitely common enough to warrant attention being paid to them.
Typically, these key Psychological levels yield the strongest reactions when tested for the first time after a long period of being untested. Whilst price moved almost in a straight line over the massive decline which occurred from summer you can see that as price tested the 1.
There are several ways that these levels can be of use to traders. Typically, this strategy works best if you look to identify confluence between these levels and other technical elements such as traditional support and resistance, trend lines or key Fibonacci levels for example.
Looking to fade price as it trades into a key psychological level where there is confluence with another key technical element can be a really great way to find entry points to key market reversals.
In the image above you can see a great example of how to identify confluence between a key Psychological level and other technical elements. The presence of a Psychological level alongside these two key technical elements strengthens the likelihood of price reversing from the level and is a great place to test the market.
Similarly, these are important levels to be aware of for trade management purposes. These levels also need to be considered when setting profit targets. Useful Psychological levels can be in helping you find entry points to the market as well as managing your trades.
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