Previous memories of good or bad trades very often will be a cause of future moves in price, writes Rick Wright of Online Trading Academy, which is why traders need to be discriminating when it comes to what trades they take.
Hello traders! Now that the US presidential election is finally over and we can stop being bombarded with half-truth commercials every 30 seconds, we can now fully concentrate on trading. Whether or not your candidate won is irrelevant. Neither showed the slightest interest in addressing the true economic problems of the US government, namely that we spend much more than we take in. So let’s talk about some charts, ok?
In every Online Trading Academy class that I teach, the statements “What was support becomes resistance” and “What was demand becomes supply” are thoroughly discussed. Many new traders have at least heard this statement before, yet are unsure why it is the case. This week’s newsletter will demonstrate why.
In the following EUR/USD chart, I have marked a demand zone that didn’t hold, thereby becoming a supply zone.
At point labeled 1, in a current uptrend price action pulled back and regained strength defining a new demand zone. But what caused this move up? Obviously greater demand than supply, but even more basic than that is the fact the people (or computers) bought here. If you bought at that point, you were making money quickly and have a fond memory of buying there. As you locked in some of those 100 pips in that move, many traders who have a fond memory of that price level will buy again when price hits that same level in the future—for example at the point labeled 2. As they realized that the next move up only made them half as many pips as the last time they traded this level, many will be reluctant to buy again there, hence lower demand at the next test of that level.
What about the people who sold short at point 1? If you were an Online Trading Academy student, you would have quickly taken your small loss and moved on to the next trade, knowing that small losses are part of the trading business. If you were not an Online Trading Academy student, you may have sat nervously on your hands, hoping that price would come back. Over the next couple of days, imagine the fear of those traders as price went against them 100 pips and slowly moved back down to their level. Finally at break even, these novice traders will very often exit their short trade, which would be another group of buyers at the same level, another layer of demand at point 2.
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Tickers Mentioned: EUR-USD