To understand the basics of market movement you have to remember a really important fact:
Trading is a zero sum game
For every buyer, there is a seller.
For every seller, there is a buyer.
So if every buyer has a seller and vice versa, then why does price move?
In this unit, we are going to look at Major Market Cycles and Pockets. Let’s start at the beginning.
As traders, what we have to remember is that we are trading the same data as everyone else in the world. Everyone else can see a previous peak in price or a previous trough. We all have the same price data (in general). We all understand support & resistance. So the idea is not to just draw some nice support and resistance lines and then trade when prices reach them because that’s only half the story. We have to learn to understand what is going on.
Why Does Price Move – Major Market Cycles
Greed, Boredom, Fear & Confusion
When you are studying your charts, you should always remember that markets follow key major market cycles. Charles Dow created his theory on market cycles and much of the work still holds true today (although his theories are mainly about the stock market, so we can modify it for other markets). His work is all freely available via Google and many copycat works have built on it. But the original work is still valid.
The theory goes on to discuss the main market cycles and how to identify them. Just be aware that markets do not start at any particular cycle and they do not necessarily follow any particular order. But understanding what they are and how to identify them, will assist you greatly with your trading.
The Market Cycles:
1 – Accumulation
2 – Mark up
3 – Mark Down (not originally part of Down theory)
4 – Distribution
This is often a sideways, quiet, market cycle and it typically has fairly clear support and resistance. You can visually see this be looking at the variance between the highs and the lows. The lower the variance between the high and low, the more solid that support and resistance is (and the more reliable it is). So it’s basically a narrow sideways range.
It is classic boredom.
Nice and simple: this market is trending higher with higher highs and higher lows. It’s often very clear visually.
It is classic greed.
Nice and simple: this market trending lower with lower lows and lower highs. It’s often very clear visually.
It is classic fear.
This is probably the most difficult cycle to define, because it’s a confused market. It can occur when one group of traders is getting out of a position when another group is getting in. So some people are dumping and some people are buying. Perhaps you have late comers to a trend at the same time you have unwinding of a previous position and you also have people looking to reverse. So the market is jumping around, not sure where it wants to go.
It is classic confusion.
Understanding the market cycles allows us to understand the current market psychology, perhaps not the reason for a specific move, but the overall trend. Understanding market cycles will also help us to select and use the correct strategy in our trading. Because when you think about it, we can all plot support & resistance levels on a chart. The ability to do this is not what defines us as a trader. What defines us as traders is what we decide to do at those levels. One trader will call a move a breakout, another trader will call it exhaustion. Some of you will buy at a certain price level, yet some of you will sell at that level. That difference of opinion is what makes the trading world go round. But time and time again, this difference of opinion happens at particular price levels.
Why Does Price Move – Pockets
Price is always looking for a fair area to do business.
At every low you will have an unfair low and at the high you will have an unfair high. As price moves up and down between these highs and lows, some buyers or sellers get. This rotation from low to high repeats again and again and buyers get trapped at highs and sellers get trapped at lows. This creates imbalance areas. Spotting this setup is an excellent and very profitable setup for a trader. We will call them pockets.
Pockets can occur in any market cycle. They can be traded in any of the cycles but will likely be most effective and perhaps most common in a distribution cycle, because buyers and sellers are most likely to make poor decisions.
A pocket is the void left behind when buyers or sellers are trapped and price moves away from their entry. These traders are then sat on drawdown (and quite often for some time, experiencing pain) and waiting for the market to retrace back to their entry and allow them the chance to get out for break even. When this happens, trades are dumped and prices move.
It’s important to note that, that with anything in trading, nothing is guaranteed, so these setups can fail (and do), but they are high probability and work again and again. It’s also important to understand this point clearly. Because sometimes the volume of these trapped trades can be incredibly high, so when they are dumped, it can move the market.
(WHY DOES PRICE MOVE VIDEO)
Choose three of your preferred markets and download at least a year of data for each. Load up the 240 minute (H4) chart for each market and complete the following:
1 – Find two examples of each of the market cycle types for any one of your chosen markets (eight examples in total)
2 – Identify 3 preferred markets and load up the 240-minute chart. Look for three examples of a pocket on each market (nine examples in total)