We are constantly rounding off numbers in our day to day activities. It occurs when we go to the market, read the temperature, buy a piece of property or go to the gas station. We are immutably drawn to round numbers and numbers that end in zero. These round numbers play a major role in Forex trading.
Why The Interest In Round Numbers?
In 1999 the Dow Jones Industrial Average hit the 10,000 mark for the first time. Investors were testing this level for almost two weeks before it finally closed over the 10,000 mark. This even was cause for much celebration as it was considered a major milestone.
About seven years later the Dow was trading at only 11,000. The investors that were driven into a frenzy when it hit 10,000 had little to show for it some years later.
In 1999 the success of the Dow was one of the most publicized events of the year. Financial news channels were running four hour specials extolling the event as the second coming. The entire market was totally absorbed by this figure.
Theories abound that humans have developed a numeric systems called “base 10” because they have 10 fingers and toes. Humans also gravitate to numbers that are factors of 10.
The Round Number Effect
Investors and traders have a very strong tendency to enter orders that coincide with round numbers. For example a trader may place an order on a specific stock when and if it falls to a $40 level. If multiple traders also place buy orders at $40 because it appears that the stock is a good buy at that level, the stock will encounter a large pool of buy orders. This often causes a large amount of buying activity and because buyers are outnumbering the sellers the value of the stock will rise rapidly.
In essence, the traders have generated what is called a “support level” at the $40 mark because multiple buy orders have accumulated at that price. This is what is referred to psychological support because it is not based on any prior price activity.
This phenomenon is common to all trading markets but is especially prevalent in the currency market. The reasoning behind this round number phenomenon in commodity, stock and forex trading is that part of humans that is attracted to round numbers. As long as people are involved in trading this phenomenon will be present.
Round Numbers In Forex
The profound influence of round numbers in the Forex marketplace should not be underestimated. A good example of this occurred in early 2005 when the USD/CAD currency pair found support repeatedly at 1.2000. Another example occurred in the early part of 2006 when the EUR/USD found support at about 1.2700. Traders that specialized in round number entry points were able to gain some great rewards.
Banks enjoy substantial commissions when they implement customer orders around these round numbers as large pools of orders tend to accumulate. The fact that these orders do tend to congregate around numbers creates a major strategy for many traders and many traders lean on this as a major trading technique.
The First Bounce Is The Best
Round number support and resistance is extremely attractive to those utilizing a Day Trading strategy. The time frames involved in day trading are typically very short. This happens because of the fact that the first bounce off of the round number support or resistance is usually the one that is the best and most profitable bounce. Traders are constantly looking to make certain that they are seeing this first bounce. Longer trading time frames are ineffective because they can often hide multiple bounces within a single candle spike.
Every time the exchange rate achieves the round number support level orders are executed. As this occurs, the pool of orders that created the support or resistance level diminishes. Once the level of orders is insufficient to affect the support or resistance level that level will eventually break.
It is for this reason that it is vital for traders to take advantage of the first bounce off the round number since it is at this point that the number of orders is the greatest and produces the biggest value. An active trader can also trade the subsequent bounces although they tend to yield smaller profits.