Markets are made up of humans.
It would be wrong to say that human psychology “may affect” the market when, in fact, human activity drives it.
When we analyze S/R levels, we look at patterns and historical data. However, another factor to consider is how S/R zones are largely shaped by human psychology.
Consumer psychology is at the heart of the forex market, and the overall direction of the economy. This idea was the very point why we analyze the market sentiments, or the attitudes of traders and investors towards the underlying asset.
If traders feel good, they’ll spend more. But if they feel uncertain, they’ll likely spend less. This is the same principle in retail, investment, and other aspects of our economy.
In reality, there is actually very little evidence to show that the way traders feel correlates with how they’re going to spend. This is because indicators of how a person feels may be hard to pinpoint.
For example, a day trader may be less confident in trading today because he found out he had cancer, or his daughter was in an accident, or maybe he was just really mad at the oil price hike.
However, there are some ways to gauge trader behavior by considering their personal income, spending, or motivation. Meanwhile, short-term gauges generally move with a trader’s domestic currency and business-level data reports.
But why should traders care about the psychology of the market?
As more market participants (humans) participate in the market, the more likely it is for common psychological behavior to be reflected in the market.
For example, numbers than end in 0 (round numbers) hold a significant psychological level for many people. If a price starts to approach a round number, it is safe to predict that activity will happen in the market.
To understand how psychology affects S/R levels, let’s consider these three traders who want to make trades in USDCHF.
Trader 1: wants to go long and waits for the price to rise
Trader 2: wants to go short and hopes for the price to fall
Trader 3: has not decided yet and is still observing the market
Let’s say that the price is starting to rise from its support level. This makes trader 1 happy and considers adding to their position if the price drops back to the support level.
Meanwhile, Trader 2 is beginning to question their position. Trader 2 may exit the position or wait for the price to reach the support level again.
Trader 3, on the other hand, may go long if the price comes back down to the support level.
In other words, all three traders are waiting for the price to drop back to its support level. Therefore, the price will likely bounce from support again.
Psychological levels are specific price points on a security that traders perceive to be important.
The key word is perceive because the importance of these prices are not based on any objective or technical analysis. Instead, they are based on human psychology or how our brains naturally function.
These levels are also referred to as “invisible lines” and are influenced by individual and institutional traders.
Identifying common psychological levels allows traders to predict patterns in price movement!
Round numbers
Psychological levels are often round numbers that end in 00 or 50. Human minds work better with estimates rather than specific numbers. Research shows that human minds respond more positively to round numbers than precise ones. The same goes for forex traders, where round prices tend to experience more activity.
Previous highs or lows
If a pair has reached a certain high or low point before, traders may assume that point to repeat. This is because the human mind responds to patterns very positively.
Historic events
Traders often gauge their decisions based on significant things that happened in the past. When deciding which currency pair to trade, traders often look at the historical data of a pair to gauge if it will be profitable or not.
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