Trading successfully in the forex market is a skill-oriented endeavor, and among the key elements that as a trader you must absolutely possess is the art of picking low-risk entries. To accurately pick these pristine areas of interest, you must first find order within the chaos, in other words, you must develop a blueprint to interpret what the charts are communicating or you risk being lost in an ever ending unstructured mess when reading price fluctuations.
It’s every traders’ aim to make a sensible judgment call to maximize the number of times one picks the right side of the market, isn’t that true? We then must combine it with a high enough risk-reward to enter what I call ‘the sweet spot’ in trading. In simple terms, that’s our jobs as traders, therefore, it’s plausible to think that discerning the dominant cycle should come high on the list as a major piece of the puzzle before you engage in a trade, right?
In this tutorial, I will walk you through how to read these cycles, which go by the name of “market structure”. My mission would be to provide a frame of reference for you to properly interpret the ever-evolving ebbs and flows under any market condition. For some traders, this guide will be enlightening, while to others it may not tick. Remember, this is just one angle to analyze the market, and by no means the only one, but it serves the purpose of providing that much-needed structure in an otherwise chaotic context.
You will be able to approach the charts in a mechanical way to constantly be in tune with the right context at play, which in its simplest form, comes down to trade trends or ranges. If you respect this model of reading the charts, I can assure you that you will be ticking yet another critical box when it comes to developing a solid analytical expertise when trading. As a result, it will allow you to pick locations to trade off for a low risk and potentially high reward.
The ABCs Of Market Structure
The first principle is the most obvious one, and it states that for a market to be in an active cycle, it’s most recent structure must be one where price prints a high that breaks the previous high (in the case of a bullish cycle). On the flip side, a down-cycle will be established if the latest swings low in price breaks below the most recent low. In this hourly chart below, you can clearly see the EUR/USD in a down-cycle phase on lower lows and lower highs.
Minimum Of Two Closes Beyond Last High/Low
To confirm that a bearish trend or down-cycle is evolving in a healthy manner, not only we need to see the low printed being lower than its previous low, but we also should expect at least two closes beyond that low or support area as further evidence that the market is accepting and building value. Failure to print at least two closes may be a precursor to what’s often referred as head-fake or false breakout, and while the move still holds its merit to qualify as a new low in the cycle, the quality of the leg is poor in nature.
Developing Rules to Validate Swing Lows/Highs
This is a key point that often gets overlooked by market participants by letting too much guessing play a role. When analyzing the charts, how do we determine what constitutes a relevant swing high/low? We need to find a mechanical approach that will allow us to qualify what we understand by relevant swing highs or swing lows in the chart.
As a general rule, if a swing low/high doesn’t make it to at least the 50% retracement of its previous swing, you probably want to disregard that price movement as not relevant enough to constitute a valid leg. After all, why would you want to consider a leg that originates from a low which doesn’t even make it to the 50% retracement as a point of interest relevant enough?
The lack of bounce should be a testament that communicates poor buy-side flows. We only want to focus on the creation of relevant and valid legs that will lead to new cycles and create in the process relevant levels of supports and resistances.
Don’t Lose Sight Of The Forest For The Trees
You must, by all means, avoid the trap of being short-sighted by only sticking to one chart analysis. When conducting your market structure studies, it’s all about building a thesis about a particular direction by finding concurrence from higher time frames down to your trading time frame. Personally, I wouldn’t recommend using more than 3 charts as your reference or you may suffer from so-called “analysis paralysis”.
What this means is that if you are going to find an entry trigger off the hourly, you should then understand what type of conditions are dominant in the immediately higher time frames. The most popular in this case would be the 4h and daily charts.
As I illustrate below, notice how all timeframes in the EUR/USD align with the down-cycle? Wouldn’t you think that trading in a context endorsed by traders from higher time frames adds to your odds of picking the direction the market is most likely to head to in your trading timeframe?
