One of the most important skills you need as a trader is the ability to read and understand market structure. More specifically, market trends. Doing so can provide the opportunity to use the right price-action strategies for the right market conditions. “The trend is your friend until the end”.
Market structure is how the market behaves during a specific period of time. It tells us who is in control of the market, the bulls or the bears? It is a tool used by many investors to figure out when to enter the market, when to exit the market, and more importantly when to stay away.
Through analysis of price action, one can distinguish 3 types of general market structures: trending, ranging, and choppy. In this article, it will become clear what these markets are and how you can identify them the next time you get caught wondering at the charts.
Like the word entails, ‘trending’ markets are characterized by a repeating sequence of upward or downward price action. For instance, a sequence of “higher highs and higher lows”, indicates an upward-moving market trend while “lower highs and lower lows” indicates a downward moving trend. The former is often referred to as an uptrend while the latter, is a downtrend. The examples below will help portray these sequences.
As illustrated in the example above, the market is making a series of higher highs and higher lows, indicating that the market is in an uptrend. In this situation, we can say that the trend has accumulated ‘bullish momentum’ and, therefore, is trending to go up due to an influx of new buyers at higher and higher prices.
Contrarily, in the example above, we can see that the market has entered a downtrend. The ‘lower highs and lower lows’ structure indicates that the market is losing support and therefore, price levels are being lost. In this example, it can be said that the market structure has acquired bearish momentum as a result of new sellers selling at lower and lower prices.
In general, spotting market trends is quite simplistic: Higher lows and higher highs mean the market is going up while lower lows and lower highs mean the market is moving down. Future articles will go into more details about how markets move in cycles using the application of theories such as Elliot Wave counts that explain the movement of price over time.
What Are Ranging Markets?
Ranging markets are straightforward (pun intended). They are often referred to as sideways markets or accumulation phases, because they drift to the right, but remain horizontal for a period of time.
This structure can be found when the market has topped out (after an uptrend), during consolidation phases (between further up or downtrends) or when the market is bottoming out (after a downtrend).
During this stage, there is no clear winner between buyers and sellers. In fact, there is a brief moment where supply and demand meet at some sort of equilibrium point between two price levels.
The chart above is a demonstration of such a ranging market as price remains between two support and resistance levels. This specific situation could potentially be an ‘M’ or double top. This is where the market tries to break through a price level twice, after initially having broken through resistance, just to be ‘rejected’ by the upper price boundary causing the price to fall. At this point, the trend reverses, as price loses a key level of support by forming a lower low on this specific time frame.
Trading the ranges is very different from trading trending markets. The reason for this is that ranging markets can switch at a moment’s notice. While an uptrend often ends with a double top (much like a downtrend often ends with a double bottom), a consolidating phase can take longer before either the buyers or sellers lose control. In such a situation, as disclosed afore, it is best to wait for confirmation before making any assumptions relating to the direction of the market. Confirmation as such is usually done with the help of EMAs and price levels, which we will discuss next week.
What Are Choppy Markets?
Choppy markets can best be described as a period of high uncertainty. This is where the price has no clear direction. There is no clear intent on either the buying and selling side. In this situation, there is also no question of a ranging market since no distinct support or resistance levels can be identified. Below is an example of a choppy market.
Market structure is one of the most essential elements to comprehend as a chart analyst. Understanding the market structure can help one’s decision-making greatly and as such must always be considered. In the end, it is best not to complicate things by “FOMOing” in at every pump and dump. More often than not, simply waiting for confirmation (such as a higher low after a period of lower lows) can help you better understand the situation at hand. This is even more the case during choppy market situations, it is best to wait. The market will always be there. As such, missing one opportunity may very well mean catching another.
The key element to take home after reading this article is the three general market structures that were discussed. If the market is experiencing higher highs and higher lows it can be in an uptrend. Conversely, if there is a series of lower highs and lower lows, it can be a downtrend. If neither of these is identifiable, try and find support and resistance zones to determine if the market is in fact ranging sideways or simply acting choppy.
All in all, experience and practice are key to becoming a successful chart reader. Technical analysis is never certain, and as such, should only be used at one’s own discretion. As such, this series of tradings articles is merely meant to act as an educational tool for the community.
In next week’s issue, we will be discussing EMAs, a very important tool that both traders and market makers use.
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