How Markets Work, in a Nutshell!

How Markets Work , in a Nutshell !

The only reason a market exists is to facilitate a trade between two partys , thats its main
purpose. In order to facilitate a transaction between two partys both need to agree on the same price ,
therefore price is “advertizing” itself all the time in order to fulfill its main purpose. The process of price “advertizing” itself
in order to facilitate a trade where two partys agree on the same price.

Price fluctuates in order to find the most attractive price on any given TF till sellers and buyers agree to make business on a certain
for them “fair” price, ie. the market found “value” and is in balance , that balance only goes on for so long till either supply or demand
exceeds or absorbed the one or the other, this creates imbalance and price is again on the lookout to balance itself and the process
of finding “value” starts again.

There must be a buyer and there must be a seller and they must agree on a price before a transaction takes place.
Otherwise, there is no transaction and no guide to value, this happens in the process of an auction market.

An auction market's structure is continuously evolving, being revalued; future price levels are not predictable.
An auction market is in one of two conditions: balancing or trending.Traders seek value; value is price over time;
price is arrived at by negotiation between buyers and sellers.

Change in demand drives change in price.

One can expect to find support where the most substantial buying has occurred in the past and resistance where
the most substantial selling has occurred.

This, balance > imbalance cycle goes on forever and ever.

What Drives Price ?

Short and Simple answer The Law Of Supply and Demand

The Law of Supply and Demand operates in all markets in every part of the world.When demand exceeds supply ,
price rise, and when supply is greater than demand, prices declines.

Starting from the simple ground that the logical action of an Instrument was to decline when offerings exceeded
the number of shares/contracts bid for, and to advance when the amount bid for was greater than the amount offered.

Anyone who ever watched at a chart could see and judge with their own eyes the momentary state of the buyers and sellers like,
their eagerness or anxiety to buy and sell at certain levels , as well as to judge the force behind the buying or selling power on any given level.
wheter it was to buy without advancing the market or to force up, or to mark it down, or to discourage buying or selling by others ,
each transaction carried with it a certain evidence, altough it is not always possible to interpret that evidence.

That evidence so to speak , was in fact only the trigger to start an orderflow which results in a certain form of price action.
The reason behind any trade ever taken is therefore the reason how orders enter and therefore are executed in the markets..
which results in a certain price action based on the response of the market on the influx of the orders.

Traders who take action do this because of a certain “cause” which leads us to The Law of Cause and Effect which also
holds true in the markets. This cause can be anything for example

one thinks an instrument is over or under valued so he takes action based on that or if one is in a open position he might exit
the position because the profit target is hit or his stop loss is hit etc.. so it basically depends on fullfilled and/or unfulfilled expectations
in order to take action in one or the other way.

Which leads us to another ingredient in the markets which is the markets/traders psychology.

In order to see an influx of orders into the markets ie. the orderflow the market psychology is cruel to how and when orders
enter the markets , but there is a difference if one is all ready in a position and needs to get out or sits on the sidelines and
waits for a favorable situation in order to get in etc.

basically we can say ,

1. there is a trigger which leads one to enter or exit the market for [insert anything here] (psychology) (cause)
2. if one enters or exits the markets he sends orders into the market using Stop/Market/Limit (orderflow) (effect) >CAUSE<
3. based on demand and supply entering the market, price fluctuates (the law of supply and demand) (cause)
4. there is a reaction or market response to the incoming executed orders which results in price action (effect) >EFFECT<

>Market Psychology > OrderFlow > Supply/Demand > Price Action



An illustrative example:


let’s say the market has been moving down all day. It’s approaching a “support” level. Everyone knows it’s a support level.
The average retail, inexperienced trader is thinking “buy support” or “sell after the break”.

So we have some people going long at this level cause it is support, it looks , feels, good to buy here or what ever PA or Pattern ,
Formation , indicator signal service etc.. says so. then all of a sudden price breaks support heavily , because we have some
people selling the break of support , which probably triggered some stop loss orders as aneffect of the earlier buyers at the level
sending price down .

So we have fresh new money (bears) and scared money (bulls) all running in the same direction at the same time! (liquidity providers)

This creates a cascade of orders coming into the market in the form of stop and market orders (orderflow) which send price down.
but only so long till there is a change in the favour of demand , like if the selling pressure cools down as most sellers allready
left the building ie. got absorbed by strong hands or simply more money (limit orders) and we have now demand in charge, (the law of demand and supply)
price will likely trade back above support (false break/fakeout) (Price Action) which allready get the bears nervous and if they
start to puke , they will propell price even further up , as their scared buying also adds to demand.. etc..

so thats basically all there is to the markets…

Pro traders trade at the extremes and let others (herd) drive price in either direction…

Price "advertising" itself and flaunting itself all over the place. This makes "Price" sound like a high paid prostitute - which might not be too far from the truth. But, that would beg the question: What does that make us Traders? It looks like each one of us might be a certified "John."


This model might work well with equities, equity derivatives, bond prices, metals, commodities (in particular), energy, etc. However, the largest international currencies have something that those other open market tradeable instruments don't have. Currencies have what's called a Compensating Balances Effect on other held instruments and/or other investments in any particular portfolio.

Thus, Currencies are often used for the sole purpose of compensating for the potential erosion of assets in other classes by shifting risk not merely into another instrument, but also into another denominated currency valuation. Major Airlines as just one example use this compensating balances method strategically using currencies all the time now, to help off-set the rising cost of Jet Fuel (as just one example) which can itself be traded on various exchanges using various international currency denominations.

Model Funds are also notorious for using international currencies to achieve a compensating balance against other held assets as well. The list goes on for potential compensating balancing acts that can be achieved through the use of such strategies. There, with currencies, that which drives price is not always pegged to fundamental supply and demand factors.


Value in currencies it not always seen as intrinsic value. The hedging aspect that some currencies offer some position traders, makes currencies very utilitarian in nature, such that some will see the "value" in currencies as being that which protects, conserves or shifts risk. Therefore, currencies can actually be utilized as tools for Risk Mitigation Algorithms as applied to other non-currency baskets or asset classes. Currencies are rather utilitarian and pedestrian in nature and their value has differential meaning and interpretation depending on which player is involved and their reason for being involved. The reason for this has to do with a currency's staying power and its reluctance to be driven to absolute zero. Thus, Currency Pairs, the entirety of the economic and political structures behind them, the massive volume they have on a daily basis, their global appeal, liquidity and relative ease of access, give them unique qualities in this regard and make them the go-to instruments for various kinds of compensating balances purposes (for many).


If future price levels are not predictable, then all pricing is completely random and by logical extension, all positions taken are completely irrational and without reason and/or justification. Essentially, if pricing is not predictable, then all positions taken have no logical basis as expectancy is reduces to somewhere south of flat zero. Thus, the entire Theory of Random Markets argues against itself. The Theory of Random Markets essentially states that absolute truth does not exist - which is itself a statement that argues against itself, as such a statement is then called into question for being true itself. So, you see, logically speaking, Random Market Theory makes little to no sense at all.

You asked the question: What Drives Markets?

Positive Expectancy is the answer. You typically hear the old standby that Fear& Greed drive the markets and this is true, but only as it suggests that a Positive Expectancy to either avoid fear or gain pleasure remains true - which is nothing but Fear & Greed in derivative form. What people tend to confuse are the multiple underlying Causation Factors that "drive the markets" and that take on one particular operational form or another. A Hedge Fund might be in the market for one reason, while an Insurance Company or a Major Airline could be in the same market trading the exact same pair at the exact same time - yet, for completely different reasons.

Their bottom line at the end of the day, whether Model Fund or United Airlines, is predicated on the positive expectancy they have in their risk models that tells them taking such positions will be long-term beneficial to their revenues and/or net earnings (in the case of an investment fund). Thus, the believe that markets are predictable rides at the core of decision making for many in the business.

At the practical level, whether or not markets are predictable is something of a trick question. One would have to first define the limits of predictability and then set out to empirically verify whether or not those limits are seen and/or observed in the market. The ultimate measuring rod for predictability is not previously determining the direction the market will take, but determining the Direction and Magnitude the market will take. One could predict Direction, yet be wrong in Magnitude and thus, never reach the specified or predicted level of profit. Thus, predictability is inherently tied to whether or not a specified target was reached and that is inextricably tied to a prediction about a markets Magnitude.

So, the whole question of predictability can be known through the empirical and historical results observed of the theory which makes the prediction itself. In other words, we don't have to guess about whether or not the market is predictable - we can postulate a theory, test it and observe both historical and forward walking results.


Actually, there are Five (5) different Market Phase with Two (2) Inverse Market Phases for a total of Seven (7) Market Phase types.

- Market Phase 1: Dominant Bullish
- Market Phase 2: Flat to Bullish
- Market Phase 3: Horizontal (Flat)
- Market Phase 4: Flat to Bearish
- Market Phase 5: Dominant Bearish
- Market Phase 2.5 and 4.5 would be the inverse phases of Flat to Bullish and Flat to Bearish.

It might be of some importance (especially to Retail Traders in the Currency Markets) to gain an understanding of these various market phases in all the relevant time frames with respect to their trading event horizon (time between entry and exit). Understanding the differentials between these market phases will also help the trader better understand the legendary myths about so-called "Trends."


In the Currency Markets, such notions of value don't apply across the board. To wit - when I trade the markets I could care less about the value of the currency pair in which I take a position. I just don't care - I really don't. What I care about are four (4) key things:

- Timing
- Direction
- Magnitude
- Probability

Thus, what I am seeking is Movement. I could care less what directional quality that movement might have, as long as the pair moves from the point at which I enter the market, through the point at which I have a specified target outlined by my trading model. The market could literally do back flips and cartwheels after I get out of my position and I would care even less if it did.

I am a Trader. I care about one thing. Consistency in the movement of the pair according to the empirical evidence used by my trading model to reduce risk and maximize profit per trade. The rest is completely irrelevant to me. I just want the market to move.


I guess one could try to get into the head of ever Trader in the market. One could look at fundamentals, economic reports and the looming news headlines and try to figure out the psyche of each Trader and how they will take positions. One could then bring that understanding into their own decision making process and note on a chart where they believe the triggering for buying or selling is taking place. But, unless one has access to the real deal order books, or unless one can actually see precisely how the buying and selling pressure is mounting up on both sides of the trigger equation, the one cannot have the depth of market knowledge and insight about what direction the market might be headed and thus, does not have sufficient real-time market intelligence to include such in their decision making about actual trade execution.

At the Retail level of Fx, the vast majority of Retail Traders simply don't have that level of market intelligence and probably would not know what to do with it, even if they did have access to it - not to mention a host of other "games" that liquidity providers and large scale players will play, in order to cloak their real intentions in the market.

This gets into the discussion of the difference and distinction between Forex and Interbank. They are not the same animal. They are distinctly different and each has its own set of unique problems when it comes to using these kinds of decision making methods that are traditionally used in equities markets, etc. Forex is Retail and Interbank is Institutional. When you trade Retail, you are trading inside a proprietary (private) liquidity pool. When you trade Interbank, you are trading global currencies on a wide open market designed for institutional grade transactions. At the Retail level, it is very likely that your Bid/Ask never sees the light of day on Interbank.


Well said.

Hi DoubleStoch , thank you for contributing ! verywell written ,

at this point iam not going into the detail of FX Spot markets.. and or how they similar correolate to the points i made above ie... all markets are the same.. etc..
as u allready made good points , with some deep knowledge .. which i lack of (regarding currencie markets)

thou , i have something to say about the quotes below...



It wasent my intend to say that the markets are random , which they are not! but its imbossible to know the future course of a price .. (crystalball)
but we can anticipate future price movements.. i have to quote a book on this subject (MarketsandMarket Logic)


Random Walk
The theory of price fluctuation as a random walk (and the term itself)
has been used for centuries. There are numerous definitions of random
walk, and each definition varies in shades depending on who is doing
the defining. According to Robert Hagin 's Dow Jones-Irwin Guide to
Modern Portfolio Theory, random walk is a term used in mathematics
and statistics to describe a process in which successive changes are
statistically independent. A random walk implies (that the market's
price displays) no discernible pattern of travel. The size and direction
of the next step cannot be predicted from the size and direction of the
last or even from all previous steps. The serial correlation is (functionally)
zero. In other words, the random walk theory holds that it is
impossible to predict tomorrow's price changes based on what has
occurred today.

One of the central points developed throughout this book is that all
markets operate similarly and are motivated by the same principles,
and that anyone who can understand these principles - plus observe
and record the individual characteristics of the specific market - and
can employ a sound trading strategy and discipline himself, can profit
handsomely from any market. Thus, a central thesis of market logic is
that there is little distinction between organized or exchange-traded
markets such as stocks, futures, options, etc. , and all other so-called
"unorganized" markets where no federally regulated exchange floor
exists. (Certainly the exchange-traded markets often offer a narrower
bid-ask spread, thus creating a higher degree of liquidity and hence
lowering transaction costs as compared to those of unorganized markets.

Every market i s an auction market, either passive o r active. I n a
passive auction, the individual does not take part in an active negotiating
process but selects from products offered at different prices which
make up the range. In an active auction, participants negotiate the
range. Whether the auction is passive or active, all markets •• auction "
or trend up and down in order to fulfill their purpose, to facilitate trade.
In an auction, prices do not develop randomly, but rather to fulfill the
purpose of the auction.

The purpose of any market is to facilitate trade. Lack of trade
facilitation inevitably causes price to move. This price movement
behavior is as true in the organized markets as it is in a grocery store
or any other everyday market. Thus, price changes to satisfy the
condition of the market and every price is a result of the condition of
the market. The fact that price moves for a specific reason further
precludes price from developing in a random manner.

Furthermore, prices are not statistically independent of each other.
Price, in moving to satisfy the condition of the market, provides an
informational flow. In other words, markets must generate trade, and
in doing so, prices fluctuate, generating information about where trade
is being conducted and where it is not. This information is valuable to
the market participant, as we shall soon demonstrate. 1 But true
randomness does not generate valuable information. In other words, in
statistically random situations, knowledge of the present is not important,
for it conveys no advantage. If knowledge of the present structure
of a market is important and does convey an advantage - as we shall
see in later chapters - a market cannot be a random walk.

We shall see how, in a futures market, the day's activity is
structured; price moves because of the degree of each timeframe 's
participation at various levels of price. We shall see why the ultimate
structure of a futures market for one day depends on the activity level
of the various groups. We shall see that the market develops logically,
as price fulfills the need of the market. And, we shall see that prices
can be distinguished from one another yielding valuable information


Well written , on What Drives Price

btw, we dont need to know the "Why" or what intentions are behind each transaction , as we can see allready by price movement , what the markets want
as a whole , therfore one just needs postion oneself in the most favourable way ..




These phases are just a "derivative view" of Balance / Imbalance ,

**for example a trendchannel** , is nothing more then a diagonal trading range , with its upper
and lower limits and a "middle" or mean .. in a rising market the mean or middle .. well u guessed it .. rises aswell

Yes, trend channels are ranges. If they weren’t, they wouldn’t be channels. However, they aren’t the result of just taking a lateral trading
range or “box” and tilting it. For one thing, the volume dynamic is different. The greatest amount of volume in a lateral trading range is in the middle.
That’s how the “middle” is defined. If the greatest amount of volume were someplace else, so would be the middle.

One could argue, in fact, that the characteristic box is defined not by its limits but (a) by its middle and (b) by how far price travels from one side of it to the other.
In any case, as price moves back and forth from one extreme of the range to the other, the transactions in the middle pile up because that’s where price spends the
most time. If one then has a lot to buy or to unload, he looks toward the middle, as explained in the first part of this piece,since that’s where the bulk of trading is
taking place ...

If one thinks instead of the middle of the trading range as the mean, many of the difficulties one might have in wrapping his mind around the whole idea of applying
AMT to trading ranges may evaporate, or at least lift, since trend channels also have means. Even the sloppy ones. And price tends to revert to the mean, along with
the traders it’s saddled with. This is called “mean reversion”.. so iguess your flat bullish or bearish fits just that .. correct me if iam wrong


Ok lets call "value" fair price then .. which is actually the same isnt it ? ,, so in your case you say well this is a "fair"price to enter because of the 4 reasons u mentioned. OTOH one sold you at this price which for him was a "fair" price aswell .. so u two partys did just negotiated a "fair" price to make a transaction

this standpoint implies just that (Traders seek value)



LOL!

cheers

extract from another thread , fits here aswell..


Yes, "value" isnt the same as price , one could say that the process of "price discovery" is a search for value ad to this
the fact that for all intents and purpose there is no such thing as "value" but rather the perception of value...

how to spot "value" in a chart ?

When Price begins to lose momentum and moves in a generally sideways direction, youve found "value" (if value hasnt been found , then price wont stop advancing or
declining until it has). Value, then, becomes that area where most of thetrades have or are taking place, where most traders agree on price.
price shifts from a state of trending to a state of balancing (consolidating,ranging) , the only two states available to it.

so.. the trading opportunitys come

A. when price is away form value and
B. when price decides to shed its skin and move on to some other value level

 

1. A Markets structure is continously evolving , being revalued, future price levels are not predictable
2. The market is in one of two conditions : balancing or trending
3. Traders seek value,value is price over time, price is arrived at by negotiation between buyers and sellers.
4. Change in demand/supply drives change in price

so how does one trade all this ?

there are only but three trading opportunitys EVER which one could consider to trade , breakouts , retracements and reversals

if one doesent understand trend,support and resistance he is going to have trouble understanding how and where and when to enter and exit
based on the three opportunitys written above...

chart example

remember a trend channel is actually a "diagonal trading range" ... only with rising / declinig value..

same picture differnt drawing .. same cocnlusion

see all u need are pre-school drawing skills to judge the market .. no indy needed

The first step for a trader is to determine the current trend of the market.
The second step is to determine one's place in the current trend.
The third step is to determine the proper timing of one's entry into
whatever it is he's trading.
-- Richard Wyckoff

where are we H1 EU ?



stayin on the sidelines on EU as of indecision on M5..... wait however that resolves itself...




will edit this post laters... as i gotta go... for now

The thing is , after we reacted at the lower channel line (oversold) we somewhat rejected the MP of the UP channel wich . per se is considered weakness
however , we made a higher low at a MP of a pot. down channel (pink) as we ll as the 50% level of the upmove got respected... one couldawoulodashoulda ..
buy that higher low... but as i cam in a lil late to the action as we allready formed a lower high.. wich in conclusion means indecison.. one should stay on the side lines
and wait how that indecision resolves itself.. such indecisions.. usually have a high potential of a momentum driven breakout eitherside , due to price filling a rather
small scale... (HL,LH,HL etc..)a hinge type of pattern.. one could bracket such a formation either side.. but i formyself dont trade breakouts that aggressively..

so i rather wait how that plays out...

OTOH if one was long at the HL .. u should stay in that trade with the SL at The lows of the HL in place... (there is still a chance to reverse that long into s hort if the market responds that way)

in this case we broke out to the upside , and we barely got a chance to catch the move on a pullback/ retracement... so it be..

...

EU H1

H1


M5




waiting on M1 for some PA.....

lets see , not the best entry (first HL best entry chance) .. but if ya late to the party .. u sometimes gotta take the extra heat..

M1

if one keeps a cool head while in the heat.. the market gives u yet another chance to participate..

anyhow.. momentum picked up... watch PA closely.. as ther could be a chance for a reversal play at arround 27500ish..

till then hold on to the long.... exit on a clear break of the veryfirst TL (tightes one)

why not ? .. lets give it a go.. .. and play that LH .. for a pot. reversal play...


towards the lower trendchannel.. and or 27340ish.. or even lower.. whow knows ?



it even might takeout the highs.... but one needs to participate in whats in front of one..

out @ lower channel line... and pot. doubble bottom..

now lets whatch this for another chance to enter on a shortside ???



depends on PA thou no limit orders here ...

why not

out for a loss




... thats it.. for now...

Hello PrymeTyme ,

So how was the day for you?

hey muhitalam



thou EU .. wasent the primary source of income.. DAX is my main fishing ground..

nevertheless , it looks like we respected the upper limit of the channel.. even thou we encompassed some indecision... (orange)
which looks like its cleared to the downside.. and we are on the way back to the middle.. (MP,Dashed blue line) and might head towards the lower limit of the channel again...

M5


thou .. one can lookout for a reversal.. @ the MP which would be a sign of strenght(long).. thou a reversal (to the downside) @ the level of 2743 should be considered
weak(short) both reversal plays.. do have its merits if taken.. as at least some reaction at those places ( if the change in supply and demand implies so,) , will at least give u some room to manage the position in a way to reduce risk... (RR) ie... dont lose that much if it doesent play out..

OTOH .... reactions @27070ish aswell as the lower limits of the channel also hold true to some pot. long plays...

Indecision , Indcesision ..



Price reacted @ a fromer MP of a hinge (27430ish) moved thru the MP of the chanel just to find support @ the low of 272xx
formed yet another hinge* just to break it to the upside and tests the highs at 27430ish again.. just to make its way back
and we see a reaction at the MP of the hinge @2728ish... ie a former "fair" price got rejectet considered now unfair low...


thus the rally halts yet again at arround our res. of 274xx .. and formes a lower high... somewhat near the MP of the channel..
all these implies yet more indecison in the market.. (chop) .. so one simply has to stand on the sidelines.. or at least only look for trades
at the extremes...

thou due to the series of higher lows towards a resistance level... where price actually doesent seem to get rejected that hard.. might implie
the making of a "springboard" ie. absorbtion** or consumption of the remaining supply at that level.. which may result in a breakout to the upside... one can position himself into this springboard at another higher low...



*a hinge hows agreement between buyers and sellers since price is compressing and the value range getting narrower
** there actually is no real absorbtion in SpotFX ..

like so..


M1

breakout!