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Forex Trading Strategy – The Psychology of Trading Round Numbers
The Psychology of Trading Round Numbers
Those of you who have followed my writings and videos for a while know that I am obsessed with the round number trade. The round number trade postulates that all conditions being equal trades in the currency market will run stops towards the round number figure such as the 1.3700, 1.3800, 1.3900 in EUR/USD or the 85.00, 84.00, 83.00 handle in USD/JPY. Of course all conditions are rarely equal so the 00 setup can be a lot more difficult than it initially appears. However an interesting confirmation of this phenomenon of human behavior comes surprisingly enough from baseball courtesy of the Big Picture blog from Barry Ritholtz.
Baseball, for most non-Americans is an unbelievably boring spectator sport where 90% of the time most players appear stand around and do nothing more than scratch themselves. In fact I would venture to say that baseball is as boring a spectator sport most non-Americans (Japanese are the big exception) as soccer (football) is to most Americans. Fortunately I was born in Europe, but raised in America so I have an appreciation for both games, so I will try to explain to our non American subscribers the key goal of baseball which is nothing more than to hit a very hard leather ball with a wooden bat (stick). This act is so hard to accomplish that those athletes who are able to connect just 3 out of 10 times are considered superstars of the sport and are known as the .300 hitters.
Here is where round number issue takes an interesting turn. Above all baseball is a sport of statistics. I could make a legitimate argument that baseball generates as many statistics amongst its rabid fans as the US economy itself. According to the latest statistical study, those players who come into the final day of the season sporting a batting average within 3 basis points (.003) of the .300 mark are inordinately motivated to get a hit and will do so at a rate far greater than mere chance could explain.
Here is the clip from Barry’s blog that describes the dynamic in detail.
“Two economists at the Wharton School of the University of Pennsylvania, while investigating how round numbers influence goals, examined the behavior of major league hitters from 1975 to 2008 who entered what became their final plate appearance of the season with a batting average of .299 or .300 (in at least 200 at-bats).
They found that the 127 hitters at .299 or .300 batted a whopping .463 in that final at-bat, demonstrating a motivation to succeed well beyond normal (and in what was usually an otherwise meaningless game).”
And here is the picture that demonstrates this aberration graphically.
What does this mean to us as traders? It means that round numbers are special. In the 1970’s and early 1980’s the Dow Jones Industrial Average approached the 1000 barrier 17 times before it finally broke through for good, but when it did it ushered in a two decade long bull run that went through 10,000 and beyond. In the FX market we see the pull of the round numbers every day. This week’s run in the Euro to 1.4000 and the consequent pullback from that level is a dynamic that repeats itself over and over. Human beings are naturally attracted to the order of round numbers and as traders we should always be aware of that behavioral tick to help us properly position our trades.