We are constantly rounding numbers in our daily activities. It happens when we go to the market, read the temperature, buy a piece of property or go to the gas station. We are invariably drawn to rounding numbers and numbers ending in zero. These round numbers play a major role in forex trading.
Why care about round numbers?
In 1999, the Dow Jones Industrial Average first reached the 10,000 level. Investors were testing this level for about two weeks before it finally closed above the 10,000 mark. This was cause for much celebration as it was considered a major milestone.
Nearly seven years later, the Dow Jones was trading at just 11,000. Investors who went into a frenzy when they reached 10,000 had little to show a few years later.
In 1999, the success of the Dow Jones Index was one of the most publicized events of the year. Financial news channels were running four-hour specials glorifying the event as a second to come. The market was completely absorbed by this number.
Theories abound that humans developed numerical systems called “base 10” because they have 10 fingers and toes. Humans are also attracted to numbers that are factors of 10.
Round number effect
Investors and traders are very inclined to enter orders that coincide with round numbers. For example, a trader might place an order for a particular stock when it drops to the $40 level. If many traders also place buy orders at $40 because the stock appears to be a good buy at that level, the stock will experience a large group of buy orders. This often causes a great deal of buying activity and because the buyers outnumber the sellers, the value of the stock will quickly rise.
Basically, traders have created the so-called “support level” at the $40 mark because multiple buy orders have accumulated at that price. This is what is referred to as psychological support because it is not based on any previous price activity.
This phenomenon is common to all trading markets but is especially prevalent in the currency market. The reason behind the phenomenon of round numbers in commodities, stocks and forex trading is that part of humanity that is attracted to round numbers. As long as people engage in commerce, this phenomenon will exist.
Round numbers in forex
The profound impact of round numbers on the forex market should not be underestimated. A good example of this occurred in early 2005 when the USD/CAD currency pair found repeated support at 1.2000. Another example occurred in the early part of 2006 when EUR/USD found support around 1.2700. Traders who specialize in round number entry points have been able to reap some nice bonuses.
Banks enjoy high commissions when they fulfill customer orders around such round numbers as large batches of orders tend to accumulate. The fact that these orders tend to cluster around numbers creates a key strategy for many traders and many traders rely on them as their main trading style.
The first bounce is the best
Support and resistance of round numbers is very attractive to those who use a day trading strategy. The time frames involved in day trading are usually very short. This happens due to the fact that the first retracement from a support or resistance level is usually the best and most profitable retracement. Traders are constantly looking to make sure they see that first bounce. Longer trading timeframes are ineffective because they often hide multiple bounces within a single candle high.
Every time the exchange rate achieves execution of round number support level orders. When this occurs, the set of orders that created the support or resistance level diminishes. Once the order level is not enough to affect the support or resistance level, that level will eventually break.
Because of this, it is imperative that traders take advantage of the first bounce of the round number as at this point the number of orders is the largest and produces the most value. The active trader can also trade post retracements although they tend to yield lower profits. Trading requires constant vigilance to be successful unless you are using an automated trading system.
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