This is a guest post from Tino @tradersreality. This article originally appeared on tradersreality.com and is reposted here with permission.
So you probably have purchased many books on price action. Price action, in simple terms, is the way price of any financial instrument behaves. it is visually recognized from the formulation of candle sticks.
This post is not your normal market theory post. You may think that this post is just my opinion. But the true reality is…The markets are machines that print money. These machines are programed by the market makers. Our job is to trade when they trade.
Candlesticks…A Little Background
I won’t go into the long description of what a candlestick is, I am assuming those who are new to forex are familiar with the image.
Now conventional trading texts all discuss the various types of candlesticks that reflect the behavior of the exchange of money, So as each candlestick develops, one is able to determine who is winning the battle to push price up or down, bulls or bears.
However, lets take a closer look into what is really happening as these candlesticks form.
Ever since the markets progressed towards electronic trading, the “Pits” ( where traders would buy and sell stock) have somewhat disappeared. Trading is now done on these massive mainframe computers that run algorithms. It’s pretty complicated. But allow me to cut to the chase.
You are trading against the MARKET MAKERS. These guys “Make” the market, they can send price anywhere they see liquidity. Now the reason why trading is so difficult is because you will never know where the market makers will push price next, if we did, then no one would lose.
Understanding How The Market Works…
It’s quite evident, the nature of the market is all based on deception. This concept is not new to those already involved in the game of speculation. However, PA appears when the psychology of the masses have been taken into account.
The market has been created for the banks to exchange the massive amounts of money that they have. The money is made on the traders who take the wrong direction and commissions from their positions opened and closed.
I used to take losses and be angry. Then I accepted one important element in trading. I HAVE NO CONTROL OF UNCERTAINTY. #TuesdayThoughts
So much money exchanges between banks to funds to retail traders. There are many discussions on the internet about the regulation of the market, but there is no way that this game is going to get stopped. Too much is at stake. Plus we need the markets to stay where they are so we can take our share.
The markets dynamics are simple especially in Forex. You need to understand the following:
- The markets are and always will be irrational. The concept of the unknown must be understood and accepted.
- The market makers will always steer price to areas of liquidity so they can get commissions for their own orders and their client’s orders.
- The illusion of uncertainty created by the market makers allows millions of investors, retail traders, banks, funds, to make an assumption about price, when really the market makers are setting up their own positions for the two phases they profit from. MARK UP and MARK DOWN.
- You will never know where the market makers will take price next. But you can build a consensus on their behavior.
Now the list above has probably taken you back. You may already be aware of how to determine how the markets move.
You would be naïve to assume that the markets have been created to connect all us retail traders so we can say we are part of the greatest industry in the world. HELL NO!! The market has been designed for one purpose. It’s to transfer the money by means of exploiting the weak, irrational, emotionally imbalanced traders ( this includes banks, funds).
So How Can We Make Money In The Markets?
To put it simply, the market makers behavior is quite obvious when you understand how they behave. I am not saying what I am about to reveal to you is the holy grail, however when the eye is trained to see what it needs to see, you then eliminate trading what you “want to” see.
So. Lets take USDJPY.
So the image above, the average trader will say that price was consolidating in a range, and then a break out occurred taking previous lows and making new lows. Now if I were to look at this chart 5 years ago, I would probably say the same. But there is more to it. Allow me to explain.
Whole, Half Numbers…
Many Studies have shown that consumers, prefer to purchase items, services, that are price tagged as whole numbers. This discussion provides insight to why this phenomenon exists. The great news is this, the markets are no different. Now we have to consider the following, seen as there is a psychology behind how people react with numbers. The market makers exploit this behaviour.
Market Makers execute the following behaviour:
They prefer to open/close short positions above a whole, half numbers, in anticipation to get the best price above the number so they can capitalise on making more money on the way down. The same for long positions.
They open and close long positions below whole and half numbers so that they can get the best lowest price below the whole and half numbers, then send price back up giving them better value for the positions they opened. Quite confusing to understand, but lets look at the image above.
You can see the ranged area (Blue Box) Now this area is trailing around the 110.000 area. Now price is not going above this number by too much because the market makers have other intentions. They are drawing in the dumb money in belief that a break to the upside will occur because of the support that is occuring at this area. However what is really happening is the market makers are building their shorts at areas they can get the liquidity to be drawn in.
Remember, market makers want liquidity, they can see all the orders in the market. However, without making it obvious, they must disguise their intentions with the whipping and whacking of price.
The average trader will think “it’s consolidating” or ” the bulls and bears are fighting it out, who is going to win” That’s the bull shit that they want you to believe. These are the ways the market makers instill fear and greed into traders minds. However if you are receptive you can avoid it and exploit it.
So you can see on the chart there are green candles and red candles appearing above the 110.000 area. Now this is not true volume, but it’s tick volume. How often price changes hands at a specific point in time. it’s these notable volume changes that the market makers cannot disguise.
As you see, price then breaks the 110.000 area on a red notable candle, breaks below the 50 day, then continues to trail down to the 109.500, the green line.
Now what has happened is the market makers got the orders they wanted above the 110.000 area. They built the short positions at the best price above 110.000, then sent price down to close the profits on the previous shorts they had built previously. (I won’t go into the exact detail of how to translate the chart above as a single post would not do it justice, but this is to demonstrate how the market works).
What you need to understand is this. You must determine whether the market makers are bullish or bearish. When the market makers send price down, they are building longs, Why? because they have the intention to close those positions at higher prices.
The same goes for when price is rising, market makers send price up so they can get their shorts at higher prices with anticipation to send price down again.
Here’s another example
Take the same pair, Price is dropping ( left side), market makers create the illusion of a sell off, they encourage traders to go short, when what is really happening is the market makers are building longs at lower prices because there are traders on the hype that price is dropping. A Consolidation occurs, then notable volume comes in below the whole number (blue line across the screen), market makers are starting to get their longs closed as price rises, then the big spike in price smashes out the stops of those who were short on the previous move down. Thus creating liquidity for their previous orders to be filled and commissions earned.
Ironic how every red candle that occurs, there is a green candle that corresponds to it at some point in the future.
I hope this post helps you understand that regardless of candle stick formations, unless you determine what the market makers incentive is, then you may be caught on the wrong side of the MARK UP MARK DOWN phase that market makers love to execute.
Just remember, we will never know where the market makers will send price next, but armed with the correct knowledge, we can prevent falling into the traps that these market makers set up in the market daily.