PSYCHOLOGICAL LEVELS
Psychological levels are often forgotten when trading, but it’s natural for us to prefer numbers that end in “0”s. Why? Because we like the round numbers, they are great for targets and great for entries. There are a lot of traders getting in and out of trades at these levels, which means more movement and more opportunities to take advantage of.
If you’re looking for a target for the buy trade you’re in and the price is heading towards the 1.4000 mark, you would naturally make this your target or look for price action around this level. Consequently we can assume other traders will be doing the same thing.
You wouldn’t see traders looking at the same chart thinking “I’m going to set my target for 1.3912”. This rarely happens. So when we talk about psychological levels and pointing them out, they are usually the round numbers and more often than not they fall perfectly in line with your support and resistance levels.
How to trade off Support and Resistance levels
Support and Resistance is one of the main confluences (reasons) to get in or out of a trade. The more confluences you can put together for a trade, the higher probability trade it will be. Here’s a really basic example of what we are talking about when we say we are looking to trade off support and resistance levels.
As you can see, these areas of resistance at the top would have been great for entering a sell trade. The first thing we do is identify the key area of resistance; look for rejection around this level. If price fails to break resistance; like the example above, you now have your first confluence to get into the trade.
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You would then use candlestick formations, trendlines and Fibonacci to build a higher probability trade setup and find the best entry to sell. This could mean dropping down to a lower timeframe for ‘sniper’ entries. Before entering the trade you would need to set your stoploss, target, apply risk management and work out the risk-reward ratio.
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We would use this as ONE of many confluences to enter a trade. Don’t jump into a trade solely off rejection of Support and Resistance levels without finding out what trend we are in (bull or bear), the market sentiment, correlation with other currency pairs and a few other confluences which we will cover shortly.
When buying or selling from areas of Support and Resistance you need to stick to some simple rules.
1) Identify the trend. We recommend looking for selling opportunities in a down/bear trend and looking for buying opportunities in an upward/bull trend. To do this, we look at all the higher timeframes and work our way down starting with the monthly timeframe.
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2) Identify the support and resistance levels and plot them on your chart.
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3) Check for candlestick formations/reversal patterns around these areas.
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4) Check for correlating currency crosses, which we will discuss more later.
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5) Follow the money management rules and work the risk to reward ratio.
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6) After you exit the trade, log and review your results.