There are important price levels in the markets – the so called psychological levels. These levels are difficult to breach, but once they are breached, there is a great likelihood that the dominant market force that aids the breach may continue for a considerable period, and the continuation may take several weeks or months. This article discusses one way of trading with this interesting idea.
»The Idea Behind the Strategy
According to the introduction to this article, there are important price levels in the markets, called psychological levels. These levels are important because they are difficult to breach to the upside or to the downside; and once they have been breached, the market forces that enable the breach could continue for a long time. When a significant support level is breached to the downside, it becomes a significant resistance level which is no longer easy to breach to the upside again, which means that the price may continue going south.
This is also true of when a significant resistance level is breached to the upside; it becomes a significant support level, aiding the bulls. The auspicious bullish forces may thus enable the determined bulls to contend with the cantankerous bears for supremacy. Wise traders would then want to join the bullish effort after a correction may have panned out. When some unwise traders notice bearish corrections, they might rush to cover their positions, thinking that bearish moves have started. When there are bearish corrections, the bears think that they have been smart by going against the trend. People do not fail in the markets because they know nothing, they fail in the markets because they do not know enough. At times, it is better to follow the trend during corrections, for one may be stopped out unnecessarily when one follows a trend when it is currently strong. When a great level is approached, there may be a serious struggle between the bulls and the bears, leading to great volatility around the level, which may result in a failure to breach the level. Should the level then get breached and the price closes above or below it, it may signal a new lease of sustained trending movement.
As it is mentioned earlier, there may sometimes be a lot of volatility and equilibrium around an important market level, prior to the inevitable breach of the level or the failure of the price to breach the level. Following a trend is a consolidating phase, which shows that the market starts consolidating after a trending move.
The consolidation is brought about by the bears’ and the bulls’ attitudes, which have become cold, as cold as the dog’s nose. The market also trends seriously after the consolidation. When a price has been in the consolidating phase for a considerable amount of time, it means that there would soon be a serious movement to the upside or to the downside. When a breakout, say to the downside, does occur, we would not want to leave our long orders at the mercy of the bears. It is like entrusting your chicken to the care of the fox. That is one fact about the markets. A typical significant level would have four or three zeros, though a level with four zeros is more significant than a level with three zeros. An important psychological level on the USD/JPY is 110.00 (three zeros), but the level at 100.00 (four zeros) is even more important. When the USD/JPY breaks the level 100.00 to the upside or downside, the bearish or the bullish force that achieves that feat would be strong enough to continue, bringing good profits for those who follow the direction. On the EUR/USD, the price level at 1.2000 or 1.1000 (three zeros each) is significant, but the price level at 1.0000 (four zeros) is more significant, i.e. when the EUR reached parity with the USD. These are examples of large round numbers in the markets. When the EUR reached parity with the USD or the level 1.0000 got broken to the downside, the bearish force that made it happen would be important
enough to enable a continued bearish movement.
Trading with the Idea
We would need to draw a thick horizontal line in order to find it easy to see when an important round number (psychological resistance or support level) is challenged and/or breached to the upside/downside. If we want to apply a thick horizontal line to a chart in Meta Trader 4, we would go to “Insert” (beside “View”) and then click on it. We would then click on “Horizontal Line.” Then the cursor can be moved up or down on the chart. Once you click on the chart, the Horizontal Line appears; which is shown in the default color red. You can right-click on the chart and select “Objects List,” from where you can edit the Horizontal Line to make it thicker and or change the color. You can also delete it here, if you wish. Apart from this manual application, there are pieces of software that can also plot horizontal lines on the chart automatically, but we are only interested in horizontal lines that help us see large round numbers easily.
Let’s check the Silver daily chart in Figure 1. You can see a thick horizontal line at 20.00, which is an important level. Whenever this great level gets broken downwards, the bearish pressure that pushes the market across the line would be strong enough to continue pushing the price downwards. The same thing is true of when bullish pressure pushes the price above the horizontal line. In the Silver chart, other horizontal lines can be drawn at 30.00 and 10.00. When you switch to the Silver weekly chart and apply the horizontal lines at 30.00, 20.00 and 10.00, and move you chart forwards, you would see how useful this idea is crossed to the downside and the price closes below it. In the future, when the price is able to reach that significant level of 1.0000 and crosses it to the upside, it is more likely that the bullish force that enables that to happen would be strong enough to continue aiding further journey to the north.
Another instance is seen in the AUD/USD daily chart, in Figure 2. An oval shape is put around the area where the price crossed the thick horizontal line at 1.0000 to the downside. The market tumbles after the horizontal line is formidable support in a bull market and as a formidable resistance in a bear market. While a psychological level like 1.0000 is very important, there are also important levels at 0.9000, 0.8000, etc.
In addition to the horizontal line, the EMA 10 also helps us to easily determine the direction of the force in the market. Further details about the trading idea are revealed in the section titled “Strategy Snapshot.” While there are times when a signal generated by this idea does not work, we tend to make serious gains when it works, especially when we are willing to let our winners run.
Spreads are not considered in these examples. The vertical red line on the left shows where a trade was entered and the vertical red line on the right shows where a trade was exited.
Example 1: We would like to show the first trading example on the EUR/CAD. In Figure 3, from February to March 2014, the price was above the level at 1.5000. Starting from April 2014, the price began to weaken, which made it break the horizontal line at 1.5000 to the downside. At the same time, the EMA 10 was sloping downwards. The crossing of the horizontal line to the downside signaled an opportunity to go short. The trade was taken and the target was hit after a few months.
Entry date: May 13, 2014
Entry price: 1.4950
Stop loss: 1.5150
Take profit: 1.4350
Exit date: August 27, 2014 Status: Closed Profit/loss: 600 pips
Example 2: In order to teach a good lesson, we would like to show another example on the USD/JPY. In Figure 4, in the USD/JPY daily chart, we saw an opportunity to go long when the horizontal line at the great psychological level of 100.00 was broken to the upside, as the EMA 10 was sloping upwards. A long position was ordered and the price moved seriously upwards, nearly reaching the target. However, in January 2014, the price began to drop considerably, and it generally consolidated till August 2014, when a very strong bullish movement resumed. Our target was reached and even far exceeded, for the price moved upwards by over 900 pips since the long position was ordered. In the chart, the candlesticks were made smaller so that a better depiction of the trade can be gotten.
Entry date: November 21, 2013
Entry price: 100.15
Stop loss: 198.15
Take profit: 106.15
Exit date: September 9, 2014
Profit/loss: 600 pips
Many traders do not have the patience to let a profitable position like this run. We can see that, in spite of desperate attempts by the bears, the price has failed to even test the great psychological level at 100.00, let alone breach it to the downside. Most traders would have exited the order in January 2014 when the bearish retracement began, and they would have done that with a good profit (despite the fact that the target was not reached). Even if the great level at 100.00 was tested, the position would have been
smoothed at breakeven. Please see where an oval shape is put in the chart. Sometimes, the horizontal line can be tested as a result of the bullish pressure, but price would fail to breach it to the upside. This does not make us go short automatically, because the bullish attempt failed. We cannot just perform the opposite of the logic in order to improve the gains, for it would be like doing brain surgery with an axe.
When a significant support or resistance level that has at least, three zeros (or four zeros) is breached to the downside or the upside, there might be a continuation of that powerful force for a long period of time. This speculation idea makes us look for position trading opportunities and be responsible after we take advantage of the opportunities. Trading is a career that demands our responsibility. Any field of thought that blames the markets for what traders experience is an irrational field of thought. However, the trading opportunities that come from this method are few and far between, so it may be added to the strategies we currently use.