When traders analyze the key levels, quite often then neglect the psychological levels in trading.
In this article, we will discuss what are the psychological levels and how to identify them.
Let's start with the definition.
Psychological level is a price level on a chart that has a strong significance for the market participants due to the round numbers.
By the round numbers, I imply the whole numbers that are multiples of 5, 10, 100, etc.
These levels act as strong supports and resistances and the points of interest of the market participants.
Take a look at 2 important psychological levels on EURGBP: 0.95 and 0.82. As the market approached these levels, we saw a strong reaction of the price to them.
And here is why the psychological levels work:
Research in behavioral finance has shown that individuals exhibit a tendency to anchor their judgments and decisions to round numbers.
Such a decision-making can be attributed to the cognitive biases.
Quite often, these levels act as reference points for the market participants for setting entry, exit points and placing stop-loss orders.
However, one should remember that not all price levels based on round numbers are significant.
When one is looking for an important psychological level, he should take into consideration the historical price action.
Here are the round number based levels that I identified on AUDUSD on a weekly time frame.
After all such levels are underlined, check the historical price action and make sure that the market reacted to that at least one time in the recent past.
With the circles, I highlighted the recent reaction to the underlined levels. Such ones we will keep on the chart, while others should be removed.
Here are the psychological levels and proved their significance with a recent historical price action.
From these levels, we will look for trading opportunities.
Please, note that psychological levels may trigger various reactions of the market participants.
For instance, a price approaching a round number may trigger feelings of greed, leading to increased selling pressure as traders seek to lock in profits.
Alternatively, a breakout above/below a psychological level can trigger buying/selling activity as traders anticipate further price momentum.
For that reason, it is very important to monitor the price action around such levels and look for confirmations.
Learn to identify psychological levels. They are very powerful and for you, they can become a source of tremendous profits.