Positioning in major volatility zones
This lesson will cover the following
- General thoughts on key price levels
- Advantages of banks and dealing rooms
- Steps to follow
Support and resistance levels are among the most important points in price movement that a trader should look for. Traders who know how to identify and trade these levels have an edge over the general public and therefore achieve higher returns. For a day trader, understanding market structure and dynamics, as well as adapting to shifting market conditions, is crucial to remain competitive. Day traders seek to profit from short-term price fluctuations, which are heavily influenced by multiple support and resistance levels – from previous swing highs and lows, to short-, medium- and long-term moving averages, as well as certain indicator levels (overbought and oversold). Thus, price zones of significant volatility and volume are key to the day trader’s trading process.
However, it is hard for a single person to keep track of absolutely everything that happens in the market; therefore, selectivity in entry points is required. This allows market participants to spend more time considering better entry signals rather than splitting their attention in too many directions. As such, day traders should focus on market movements accompanied by large order flows, when a broader market reaction is more likely.
- Trade Forex
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- Regulation: NFA
- Leverage: Day Margin
- Min Deposit: $100
Best entry points
Moving-average penetrations, moving-average crossovers and, especially, round numbers tend to be very lucrative areas for trading. We have already discussed moving averages and moving-average crossovers in the articles ‘Introduction to Moving Averages’, ‘Simple Moving Average’, ‘Exponentially Smoothed Moving Average’ and ‘Moving Average Crossover’; therefore, in this article we will turn our attention towards round numbers, commonly referred to as ‘double zeros’.
Round numbers are widely traded points in price movement that attract greater volume than many other areas due to the overall simplicity of the trading opportunities they present. Double-zero reactions are very suitable for day traders as they have a more favourable risk-to-reward ratio than many other scenarios. It is an easy-to-grasp trading method; nevertheless, it requires a good understanding of crowd behaviour and an accurate assessment of market sentiment in order to predict properly whether the market will penetrate or rebound from the double-zero level.
You also need to understand how dealing rooms and large banks operate at these price levels. Large banks, which have access to the number and types of conditional orders (stop-loss, take-profit, limit orders), have a major advantage over the general public of traders because they obtain an early insight into market players’ potential reactions at different support and resistance levels.
Significant advantage
Possessing this type of information and having huge capital at their disposal allow banks to enter short-term positions that push the market to trigger traders’ stop-losses. Dealers can exploit this information in the same way. This is easy because traders tend to cluster their conditional orders around certain price levels – in our case, round numbers. While stop-loss orders on long positions are usually bunched several pips beyond the double zeros so that random noise does not trigger them, take-profit orders on short positions are typically set at the double-zero level.
Knowing exactly how a large part of the market is positioned allows banks to exploit this knowledge and run their stops. As the price drops towards a double-zero level, bears’ take-profit orders at the round number are triggered, and bulls enter with stops below the double-zero level. Banks and dealers then fade the round number and go short, pushing the market down and running those stops before exiting their positions several pips later and allowing the market to resume its upward movement.
How to trade round numbers
In order to achieve the best possible profit, certain conditions must be met. The price must be trading well below the 20-period moving average on the 10 or 15-minute time frame. Additionally, the trade stands to profit more if the significance of the double-zero level is supported by technical indicators such as moving averages, moving-average envelopes, Bollinger Bands, Fibonacci levels, etc. This strategy works best during calm market conditions; thus, economic data releases are best avoided.
When all the conditions listed above are met, you can proceed with the trade itself. Let’s assume we are aiming for a long position. As the price drops well below the moving average and penetrates the round number, you need to go long at several pips below the round number. For example, if EUR/USD 1.2900 is penetrated, you should buy at EUR/USD 1.2893-1.2895. You need to place a protective stop between 15 and 25 pips below your entry point – ideally 20 pips (in our case, around EUR/USD 1.2873-1.2875). The price is expected to drop a bit further and then rebound as banks and dealers cover their shorts. If it doesn’t, your stop will be hit.
However, if everything goes according to plan and your position becomes profitable, you should scale out of it in two or three increments. You should close half of your position and lock in profit when you earn double the amount you have risked – in our case, as EUR/USD reaches 1.2933-1.2935. At that point, you should move the stop on the remainder of your position to the break-even level – 1.2893-1.2895 – and, as the market continues to move in your favour, trail your stop using either a percentage or absolute basis, whichever is your preferred method. See the following example.
As you can see in the screenshot above, the AUD/USD cross penetrated the 0.9400 level on two occasions, but we decided not to fade the first one because the market was in a bull trend, implying a higher possibility of a genuine breakout rather than a fake-out, and also because there were economic releases at that time. However, the second double-zero spot was ideal, because the previous bull trend had reversed and was forming lower highs and lower lows, and there were no economic releases from either the US or Australia.
We enter short at 0.9405 and place a protective stop at 0.9425. The market pushed a bit higher to 0.9410, but then reversed as expected. Our profit target of double the amount risked, i.e., 40 pips, was reached at 0.9365. At that point, you can either square your position or leave a portion of it in the market and use a trailing stop. In our case, the latter strategy would have squeezed out a few extra pips.