We’re social creatures, we just can’t help but notice what each other is doing. Even those that say that they don’t care about what others think; ya, well that’s a carefully crafted statement designed just to engineer what you think about the person saying it. Ironic yet, common.
If you were to hear a loud crash and boom right this instant, odds are you would look around to the people around you and how they’re reacting before you actually decide how to craft your own reaction. This is why when you’re in a movie theater, if you do that kind of thing anymore, and something incredible happens in the film that you’re watching – if you look around the theater you’ll catch the gaze of others.
This is also why social media has taken the populace by storm. For the first time in our lives, others are watching even when our windows are closed. This creates a competition and almost a form of animosity amongst people that propagates even more competition.
Everyone wants to say the world is more divisive than it’s ever been. I prefer to call it competition.
In markets this plays through quite a bit, especially with technical analysis. The whole premise of technical analysis is that it might be a self-fulfilling prophecy. That if I notice something, like price testing a 200 day moving average, and you notice it and Joe notices it – well if enough of us notice it and actually do something about it, it can fulfill its aim without any additional exogenous pressure.
What are psychological levels
Psychological levels are probably the simplest and most clean manner of expressing this relationship. A psychological level is simply a rounded whole number, like 1.00 or 100.00. But if you think about it, we as human beings operate in these whole number intervals because we value simplicity. If I asked you how much you paid for your car, you’d probably say something like 30,000 or 30k – not 29,765.89. Because the truth is I don’t care about the exact amount, I’m just looking for a ballpark idea and likely, that’s all you’re willing to give me.
Markets work this way, too.
If prices are running higher, stretching up to a fresh all-time-high, and one of these brick wall levels is about to appear, we’ll often see some funny business show up. It’s unlikely that we’d see business as usual, with prices just continuing to trend higher, right through the level and beyond. More likely, we’ll see a bit of gamesmanship. Buyers begin to slow as the brick wall appears: They’re not stupid, they know we’re likely nearing resistance, so this is not the best time to buy. Instead, might as well wait, let resistance play out and try to pick it up at a lower price.
And when that level finally does come into play – well now there’s motive for sellers to take profits, and this can allow for prices to pull back. And with selling pressure showing after prices had inclined a new level of resistance, well that’s even less motive for new buyers to come into the market, and this can cause price action to pull back below the psychological level.
Eventually, if enough motive remains and if the trend has enough firepower to continue, buyers will take out that resistance. But its not without a struggle at these major levels on the chart.
Major psychological levels
Major psychological levels are at significant price points. In the FX market, this is usually prices ending in 000’s. So in EUR/USD, 1.0000, or parity would be the most obvious, but 1.1000, 1.2000, 1.3000, 1.4000, 1.5000, etc. In stocks, this is usually in even $10 increments, unless we’re talking about a stock that’s trading at over $1,000, at which point the major levels would be even $100 increments.
On the below chart, I’m looking at AUD/USD with only major levels identified. But notice how many significant market tops or bottoms get caught at these significant way points. And when markets turn from these levels on the monthly chart, those trends or retracements can last years and years.
In between each of the major levels is a mid-point. So in FX, this would be in 500 pip increments in between each 1000 pip major level. These areas can similarly get some good inflections but they usually don’t stand as tall as the majors.
On the below AUD/USD chart, I’ve applied the primes and I’ve added a green box around some of the more noticeable inflections. It’s not as actionable as the majors; but the big value in the primes is on shorter time frames, which we’ll get to in a moment.
This is where we can start to make the concept of psychological levels a much more usable medium for short-to-intermediate-term trading intel.
Like the primes, the minors cut in between the larger levels, so minors are in each 250-pip increment in FX, or 2.50 increments in stocks trading below 100.00. The minors are levels that can see considerable action, often as support or resistance but also as a bias-level for when that price is broken.
So if 1.0750 functions as resistance, and then bulls bid prices back up, that level can be used for bullish breakout potential on 2nd or 3rd tests.
In case you haven’t noticed yet, the strategy with levels is basically divide and conquer. We’re going to split our minor levels again with what I call shorter-term levels. These are plotted within 125 pip increments on an FX chart and similarly, can offer a number of inflections for traders to use. I’ve circled a number of inflections on the below chart, highlighting the effectiveness of psychological levels in the traders’ approach.