What causes price action to do what it does? Have you ever looked at a currency chart and wondered what causes all those familiar price patterns and, more importantly, what it’s going to do next?
Of you have, because that’s the nature of technical trading. It’s in our DNA to look for reasons, for patterns, for answers in a seemingly chaotic market because we strive to understand and see order in the world around us.
And because it is in our nature it means that every other trader out there is looking for the same thing. When we look at a chart, we look for significance in the price action. Why did a price break through resistance? Where there any clues? Was momentum on its side or was there a discernible pattern we could measure and apply in the future as a clue to price continuation?
Or if the price bounced, why did it bounce? Why would price move with such force towards a point only for everyone to say “ok, that’s enough” and reverse?
The answer lies in our psychology and is the reason why bounces (reversals) are a more reliable trade and more common than break (continuation) trades.
When price bounces, there’s often a visible barrier on the chart which the market rejected because collectively, you, me and most other traders felt that the currency pair had no business jumping the fence and effectively swimming in fresh waters. Jumping these barriers values the currency in a whole new price range and takes significant will to push it from one price range into another.
For price to break the barrier and continue, it means that enough traders around the world thought that the currency was valued incorrectly and had enough conviction in their view to put significant money behind the move and push it through the resistance level.
That’s why price will often breach a resistance level, only for the breakout to fail and close back inside the range. If a price breakout fails, the majority of traders will instantly back the reversal and keep the price in a range they know and feel comfortable with.
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Adam – TheDayTrader