How to trade price action and market structure

How to trade price action and market structure like a pro

How to trade price action and market structure

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Many people believe that price action and market structure are random and unpredictable.

Analysts and traders tend to believe that they have some edge over the market, that there is some predictability in price.

This camp divides into two groups that historically have been diametrically opposed:

  • On the one hand, fundamental analysts and traders make decisions based on their assessment of value, through an analysis of a number of factors such as financial statements, economic conditions, and an understanding of supply/demand factors.
  • On the other hand, technical traders and analysts make decisions based on information contained in past price changes.

There is a language to how price moves that is based on an alphabet of each day’s opening, high, low, and closing price. 

The purpose of this post is to give you some powerful tools for analyzing how price action evolves and creates market structure. We also share details on how to use that information.

You should definitely take the time to read it until the end if you want to make it as a trader.

This blog post is aimed at both beginners and advanced traders. There is more advanced content in the last part.

Price action and market structure cheatsheet by @subvertoxbt
Price action and market structure cheatsheet by @subvertoxbt

Price action and market structure to rule them all

As supporters of technical analysis of price,

The key distinction, for us, is that technically we acknowledge the primacy of price itself.

What do we mean?

We consider that it is useless to look for a narrative to explain price movements.

Does this mean that the price moves erratically?

No!

The interest?

Do not disperse. 

We focus on only one thing: price action and market structure. 

Why? 

Price represents the final product, the realization of any analysis.

Therefore, price is the meeting point for the decision-making of all market players.

No matter if these players use technical analysis, insider information, nothing at all or fundamental analysis.

E.g. we postulate that those who may have had information “before everyone else” (the famous insiders) have already acted, thus leaving their footprint on the price.

Therefore, we firmly believe that a careful analysis of price development reveals areas of imbalances in the market forces, which therefore offer interesting profit opportunities.

This is the reason why you need to learn to read price action and market structure. 

General principles to chart price action and market structure

Why do we use a chart to read price action and market structure?

If you have begun your study of the markets, you already know it is a visual world, where charts prevail.

Charts are powerful tools for traders, but it is important to think deeply about what a chart is and what it represents.

The idea of a chart in the first place, is to illustrate where the price of a security has been over time.

Supply and demand sets the price of something, and the chart is a graphical representation of the historical changes in supply and demand, ie, the historical changes in overall thinking towards the product being viewed, as set by buyers and sellers.

Though it is possible to trade by focusing on simple chart patterns, this approach also misses much of the richness and depth of analysis that are available to a skilled price action chart reader.

Top-level trading combines traditional left brain skills of logic, math, and analytical thinking with the intuitive, inductive skills of right brain thinking.

Charts speak directly to the right brain, whose native language is pictures and images.

Part of your edge as a discretionary trader comes from integrating these two halves of your being.

Clean charts:

  • are a powerful tool that can facilitate this integration and foster the growth of intuition.
  • put the focus where it belongs: on the price candles and the developing market structure.

What is best to read market structure: Bars or candles?

Most traders today seem to be focused on using candlestick charts, but the more old- fashioned bar charts should not be overlooked.

Both chart types display the same data points but in a slightly different format.

They have the same information on them, so one is not better than the other.

The main advantage of bar charts is that they can be  visually cleaner and it is usually possible to fit more data in the same space because bars are thinner than candles.

What i especially like in bar charts, is that the bars are not color based. For intraday, it helps to keep cold pressure when sometimes emotions enter the game.

For many traders, the colors of candlestick charts make it easier to see the buying and selling pressure in the market, providing another important visual clue that helps the trader process the data faster.

Log scale or Linear Scale?

The one exception to the principle of keeping charts consistent might be in the case of very long-term charts spanning multiple years, or shorter-term charts in which an asset has greatly increased in value (by over 100 percent).

In these cases, the vertical axis of the chart should be scaled logarithmically to better reflect the growth rate of the market.

The idea behind a log scale chart is that the same vertical distance always represents the same percentage growth regardless of location on the axis.

On a very long-term chart, linearly scaled charts will often make price changes at lower price levels so small that they disappear and they are completely dwarfed by price changes that happened at higher levels.

The linear scale also magnifies the importance of those higher-level price changes, making them seem more violent and significant than they actually were.

Compare the two charts right under 

They seem to tell completely different stories. 

The first chart shows a flat and uninteresting beginning followed by violent swings near the right edge of the chart, while the second, the log scale chart, shows more consistent swings throughout.

Over this long history, the log scale chart is a much more accurate representation of what market participants would have experienced at any point on the chart. 

Remember, as a rule of thumb, there are two times when log scale charts should be used:

  1. any time you have greater than a 100 percent price increase on a chart,
  2. and for any chart showing more than two years of data, whether on daily, weekly, or monthly time frames.
bitcoin long term through a linear chart
bitcoin long term through a linear chart
bitcoin long term through a log chart
bitcoin long term through a log chart

The importance of the opening price for market structure

Annotate your charts with yearly, monthly and weekly open

Price does not dance to the beat of some mystical, magical drum that hides deep in the recesses of a plush room in New York City, and has a rhythm only a few insiders recognize.

Price jumps all over the place, and our charts become erratic because human emotions are influenced by news and brokers’ hot tips of immediate boom or gloom.

Whereas chartists have strange names for almost every market wiggle and waggle, they have seemingly missed the major point of the market, which is that price moves in an amazingly mechanical fashion.

You should always mark your charts with the yearly, montlhy and weekly open; and if you are an intraday trader, with the daily open.

Why? Because of unfilled orders (it refers to an order to buy/sell that was only partially filled) and order flow. 

Price moves from liquidity areas and come back to them

When the year, month and week comes to an end, the big players look to cover, alter or open new positions.

As such, lots of “order swapping” takes place, and with it, unfilled orders are often left behind: liquidity remains in the same place. 

Not clear ? Well, imagine you are a big forex player in a strong position.

You planned to add to your position going into the month’s close, as the instrument being traded was showing signs of strength.

As a big player, you need price to reach a big liquidity zone to fill your orders. Otherwise, your account will just get wrecked by slippage (When you are trading several hundred lots, one cannot just market buy/sell, as slippage could place you in a very awkward position, far away from your entry point.)

So, bigger fish usually qualified as “smart money” enter the market incrementally, and by doing so, do not always get their entire position filled.

Therefore, big fish have the choice of leaving the order in place unfilled so as price can pick it up when/if the market returns.

This is:

  • what generates a reaction from these levels from an order flow perspective.
  • partially responsible of price’s memory.

How does one use the opening price to read price action?

How does one use these opening levels?

Don’t use it as a stand-alone tool. Always look for some confluence. 

As you are now aware of some basic principles of smart money and order flow principles, you need to understand that our charts are a record of price activity over time.

And who is price made of?

Every player. From retail to institutional money. 

But at the same time, who wins in the market: retail or institutions?

If you want to make money in the market, you should stop thinking like a retail trader and start trading as institutions do. 

So a good way to use these levels is to understand them from an accumulation/distribution point. 

After an accumulation stage, there is an expansion stage, and a distribution stage. 

You need to make sure you’re not the retail money aka “the opposite side of the trade for smart money”. 

Some drawings are sometimes more effective than a long description.

Be sure to understand them because every candle is here to tell you a story.

So learn how to read the book. Or die.

Hereunder are two stories:

  • One of smart money and dumb money’s behavior in a bullish environment.
  • And one of smart money and dumb money’s behavior in a bearish environment.

Every candle tells you a story about market structure

For now the key thing to understand is that candlesticks are a graphical representation of price movement, and therefore show the market’s thinking and sentiment, and any changes in this thinking and sentiment that may be unfolding. 

This is why price tells you a story: Because a candlestick can be broken down into its component parts to work out the direction of travel that it represents for price.

The stories go from very basic to advanced logic.

Basic principles of psychology through price action

A candlestick with a green real body is created on a day when the market closed higher than where it opened:

  • In other words price moved higher over the course of the day.
  • This means, if you use the basic principles of supply and demand, there were more buyers than sellers. To put it into the market parlance that I will use from now on, the bulls won the day.

A candlestick with a red real body is the result of a day where the market closed below the level at which it opened.

  • This means the sellers outweighed the buyers, or there was more supply than demand, resulting in price moving lower.
  • In market terms it was a bearish day.
Well, nothing new here.

Advanced principles through the example of a reversal single candle pattern.

The analogy with soccer

Well, i am not going to cover too many candlesticks patterns but just one to give you an example.

Let’s talk about the shooting star that unfolds a Bearish reversal pattern.

It is a single candlestick in a rising market with a long upper wick and a small real body at the bottom end of the candle’s range.

So let’s think about the price action that goes into the construction of a Shooting Star.

I often talk about charts and the markets using sporting analogies, many of these using my beloved soccer team.

This session was akin to a match that was pretty quiet and predictable in the first half, and honours went to the team in green, who trotted in 1-0 up at half time.

Incidentally the team in green had won 5 of their last 6 matches, so no one was that surprised that they were winning this one, especially as the blues were near the bottom of the league.

But in soccer, sometimes things change. Greens aren’t going to be the best team in the land forever, thank heavens!

The blue team’s manager says something at half-time, and the second half starts with a bang.

Over the next 45 minutes we are treated to the best display of football in living memory, with goals galore, and by the end of the game the blues win 5-4.

  • Whose fans go home happier?
  • Which team is likely to feel better going into the next game?

Generally the team that dominates the second half of a match will finish the stronger and win the match. 

It is exactly the same with a day in the life of the markets.

In a bull market, if the bulls win the first half, but the bears win the second half, and the bears keep their pressure on until the end, we’ll likely post a candlestick with a long upper wick; a Shooting Star.

Can you see how even a single candlestick can be an extremely effective reader of price action and market structure over a particular time period?

Psychological analysis of a shooting star.

In a shooting star, the bulls are in charge going into the session, remember that. So when the market starts to rally in morning trade no one is surprised.

The bulls continue on their happy way while the bears continue to get beaten up.

But at one moment, the balance between buyers and sellers changes and the buyers are suddenly not dominating anymore.

The second half of the session is a ding-dong affair.

I’m sure you’ll agree that the long upper wick definitely smacked of a rejection of the upside.

I may seem like a stuck record at the moment, but by making sure you get used to the idea of thinking about the direction of travel that goes into the construction of a particular shaped candlestick, you will breeze through the rest of this post, and market structure will immediately become a strong ally in your trading.

Well, never make a decision based purely on one candlestick pattern being posted.

This is common sense, surely.

When you buy a jumper do you have one criterion, ie, “it must be red”, and do you go out and buy the first red jumper you see?

Or do you also want to have a certain type of neck, and a specific style, and a particular material or texture? Of course you do!

This is where academics get it all wrong where technical analysis is concerned.

To put it in simple terms they look at something like candlestick analysis and say “we tested 500 occurrences of a Hammer and only 100 gave us a 300 point rally after they appeared, therefore candlesticks are rubbish.”

Ok. Thanks for nothing actually. Academics don’t generally wear very nice jumpers, do they?

How to make it as a trader: the true secret of price action and market structure

Defining price action and market structure

Price action is the term used to describe the market’s movements in a dynamic state.

Price action creates market structure, which is the static record of how price moved in the past. 

Think about a finger tracing a line in the sand:

  • Market structure is the line left in the sand;
  • Price action describes the actual movements of the finger as it drew the line.

In the case of a finger, we would talk about smooth or jerky, fast or slow, and lightly or with deep pressure into the sand.

In the case of actual price action, we would look at elements such as:

  • How does the market react after a large movement in one direction?
  • If aggressive sellers are pressing the market lower, what happens when they relax their selling pressure?
  • Does the market bounce back quickly, indicating that buyers are potentially interested in these depressed prices, or does it sit quietly, resting at lower levels?
  • How rapidly are new orders coming into the market?
  • Is trading uni-directional, or is there more two-way, back-and-forth trading?
  • Are price levels reached through continuous motion, or do very large orders cause large jerks in prices?

All of these elements, and many more, combine to describe how the market moves in response to order flow and a myriad of competing influences.

As a summary, let’s say:

  • Price action is the dynamic process that creates market structure. It is also more subjective; in most cases, market structure is concrete.
  • Market structure is static and is clearly visible on a chart, but price action usually must be inferred from market structure.
  • Also, both are specific to timeframes, though price action is often visible as the market structure of lower time frames. 
Now, it’s time to learn how to decode these hieroglyphics so we can all solve the puzzle together.

The basic units of market structure: Short term High and short term Low

The first letter to master tells you what market activity causes the formation of a short-term high or low

If you learn this basic point, the meaning of all price action and market structure will begin to fall into place.

The basic units of market structure on any time frame are short term highs and lows (also called pivot highs and pivot lows).

  • A pivot high is a bar that has a higher high than the bar that came before it and the bar that comes after it.
    • At least in the very short term, the bar’s high represents the high-water mark past which buyers were not able to push price,  
    • Can be considered a very minor source of potential resistance.
  • A pivot low is the same concept inverted: a bar with a lower low relative to both the preceding and the following bars.
    • At least in the very short term, the bar’s low represents the low-water mark past which sellers were not able to push price,  
    • Can be considered a very minor source of potential support.

Note that it is possible for a bar to be both a pivot high and a pivot low at the same time, and that pivot highs and pivot lows are very common.

The following picture shows a chart with every pivot high and pivot low marked. 

As you can see, they are so common that they cannot be extremely significant.

But they are your first step to create order from the chaos of a chart.

Short term High and short term low identified on a chart as first step to read market structure
Short term High and short term low identified on a chart as first step to read market structure

Now, i guess you come to me with a question: What do we do of inside days ?

An inside day means the market has entered congestion, the current swing did not go further, but then again it did not reverse, thus until this condition is resolved, we must wait and not use the inside day in our identification process.

Well simply ignore inside days and the possible short-term points they produce. 

Intermediate and long term pivots

Now,  we can take a step forward and identify intermediate pivots:

  • Intermediate pivot high: Any short-term high with lower short-term highs on both sides of it.
    • At least in the mid term, the bar’s high represents the high-water mark past which buyers were not able to push price, 
    • Can be considered a decent source of potential resistance.
  • Intermediate pivot low: it’s just the opposite: Find a short-term low with higher short-term lows on both sides and you have found an intermediate-term low.
    • At least in the mid term, the bar’s low represents the low-water mark past which sellers were not able to push price,  
    • Can be considered a decent source of potential support.
Let’s have a look to the arrows on the following chart.
Market structure and price action Intermediate High and Low
Market structure and price action Intermediate High and Low
As a consequence and logically, we can say that a long perm pivot is:
  • Long term pivot high: Any intermediate-term high with lower intermediate-term highs on both sides is a long-term high.
    • At long and very long term, the bar’s high represents the high-water mark past which buyers were not able to push price,
    • Can be considered a major source of potential resistance.
  • Long term pivot low: It is any intermediate-term low with higher intermediate-term lows on both sides
    • At long and very long term, the bar’s low represents the low-water mark past which sellers were not able to push price,
    • Can be considered a major source of potential support.
We have now been able to define the three dominant swings in price action and market structure.If you look at the picture hereunder, you will understand market structure and will see that we can create order out of much of the chaos.
Market structure and price action Long term high and low
Market structure and price action Long term high and low

Why price action and market structure matter

Connect the pivots to discover the magic: the incredible power of intermediate and long term pivots

Once we have defined the intermediate and long term high/low, we can connect these swings highs and lows with lines to outline the swing structure of the market.

If this type of analysis is new to you, train your eye on a few hundred charts until it becomes intuitive.

With some practice, you will be able to glance at a chart and see this structure immediately.

Like everything else, it gets easier only with continued practice and familiarity.

It is impossible to overstate the importance of this skill.

Once the individual swings are delineated, we can start to consider what the market structure actually tells us about the balance of buying and selling pressure and price action.

The core concepts are simple:

  • When buyers are stronger than sellers, upswings will be longer, both in price and in time, than downswings.
  • When sellers are in control, downswings will be longer than upswings.
  • Significant support and resistance levels are visible as rough areas beyond which price have been unable to penetrate and close.
  • When there is relative equilibrium, there is no clear pattern to the swings.

There is nothing mysterious about market structure and price action.

Understand the market structure in order to identify a trend and ride it successfully…

Complete price action and market structure identification chart
Complete price action and market structure identification chart

Follow the trend from the beginning till the very end

Focusing on the variations is difficult because they are legion.

It is an exercise in futility to try to catalog all of the complexities and variations of patterns.

Understand the root.

Understand the market structure.

Being able to read correctly price action and market structure allow you to identifiy the birth of a trend in a very early stage.

And why does it matter ?

Because you will make the most of your trading money riding a trend. 

A trend exists in a market when price keeps rising or falling over a period of time:

  • In a perfect uptrend, each rally reaches a higher high than the preceding rally, while each decline stops at a higher level than the preceding decline.
  • In a perfect downtrend, each decline falls to a lower low than the preceding and each rally tops out at a lower level than the preceding rally.

And when the market is not in a trend, you get a trading range: most rallies stop at about the same high level, and declines peter out at about the same low level.

Most of the time, the markets evolves in a range: this is a random environment in which the conviction of buyers and sellers is relatively equal and there is no clear pattern.

Then, it breakouts and creates a trend.

Your job as a trader is to flow with the trend. Don’t resist it.

Then, start looking for flipping bias once there is a break in market structure.

Here are a few pictures depicting trends.

Price action and market structure cheatsheet by @subvertoxbt
Price action and market structure cheatsheet by @subvertoxbt

Market structure keeps you on the right side of the market

Decipher market structure that unfolds from price action. 

And if you find a trend, please, just FOLLOW THE TREND. 

Never fight it.

This is why we called  for a buy at 6700 usd in this video, and an other one at 6850 usd… on the bitcoin H4 chart. 

Why? 

Because the macro trend was asking for relief.

How does it translate to market structure?

By a lower timeframe uptrend.

You can notice also on this tweet that the idea was scarce because we only got… 2 likes.

The public was indeed on the opposite side of our trade

Good sentiment for us and one more element to confirm  the shift in our bias.

market structure of bitcoin on H4
market structure of bitcoin on H4

One little secret: How to define a target using market structure?

This is not the technique we always use but we are exposing it to you, so you canbacktest it and use it in your own strategy if it fits.

As mentioned, we are more inclined to set dynamic price target rules. Nonetheless, we like to have “an idea” of where and how high/low price is headed.

Market structure can help you in that matter:

To define a price target, let’s assume we have just printed an intermediate low.

You can take the distance from the previous high to the intermediate-term low, then add that value to the most recent intermediate-term high.

That gives us our target or upside potential.

But don’t be biased.

If price reaches your target but doesn’t show any weakness, or a break in market structure, you have no reason to cut a runner.

Just let it run, wait for a break in market structure, then, take profits on the bounce, or stop out of your trade.

Defining a trading target using market structure only
Defining a trading target using market structure only

Conclusion

There is something mesmerizing about price action and market structure as Jessy Livermore used to say.

Many people believe that price changes are random and unpredictable.

If this were true, the only logical course of action would be… not to trade!

Reading price action correctly will allow you to understand and extract the market structure from your chart.

Once you get this edge, you can stay on the right side of the market.

Then, you can sit tight. 

We hope this blog post will helps you solve the puzzle of the market and make some good profits !

If you liked the post, feel free to comment, DM us and encourage us to keep creating free content for you. 

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