Here's a harsh truth:
Most supply and demand zones are weak with little chance of triggering a significant reversal, if any reversal at all!
But how can you quickly spot these weak zones?
Can you even avoid trading them?
Yes!
It's simple:
Analyze the immiideate move preceding the zone.
Weak supply and demand zones never form after long, sustained rises or declines like their more powerful counterparts. Weak zones always emerge after a short-term price move, such as a tiny retracement or minor pause.
Remember this rule of thumb: The shorter the preceding move, the weaker the zone.
Example:
Check out the small up-move before this supply zone formed.
Compared to the uptrend/upswing seen in the previous example, this rise is TINY, only lasting a measly two days! Why is the rise so small? Because it's a bullish retracement to a much larger downtrend.
Quick Question:
If price is trending lower, what are most retail traders doing: buying or selling?
Selling, of course!
Why are they selling?
Because they see a trend!
What's the Definition of a trend again? "The longer price moves in the same direction, the more likely it is to continue in that same direction."
Haven't we heard this before...?
These traders believe price will continue falling indefinitely. Since almost everyone is selling due to the downtrend, do you think many traders buy when the price retraces?
HELL, NO!
Traders already short remain in the downtrend—they think price will fall forever! Traders sitting on the side see the retracement as a chance to sell at a cheaper price. Nobody thinks... "Hmm, maybe price is reversing; I should get long now." Because the downtrend is clear to everyone in the market... (Some traders enter long, but not many).
With few traders buying during the downtrend, banks lack the necessary buyers to execute large sell trades. This means any supply zone forming at this point will be inherently weak. Since the banks can't sell in significant quantities, they won't be overly concerned if price breaches the
zone and moves higher.
By the time the price returns to this weak supply zone, the small sell orders that initially triggered the reversal will likely be closed.
Key Takeaway:
Exercise caution when trading zones that form late into upswings or downswings.
Zones created towards the end of a sustained price swing often weaken after formation. Banks will often close any orders associated with these zones as the swing continues, significantly reducing the zone's potential impact when the price revisits it.
Why do banks close these orders?
The longer a price move continues without significant consolidation or retracement, the more likely it becomes that a correction is imminent. Banks need to shake out retail traders to prevent the market from becoming overly one-sided, as they can't profit with most retail traders open in
the same direction.
Forex is a zero-sum game!
How do banks shake out traders?
By initiating a retracement or consolidation, either through taking profits or closing smaller open trades. This reversal causes late-entry retail traders to lose money, allowing the banks to enter new positions at more favorable prices and potentially invalidate recent zones.
What happens in the example...
As a trend persists, more and more retail traders become aware of its existence, making the trend increasingly obvious to everyone.
The consequence?
A growing number of traders pile into the trend, entering trades in the same direction.
Here's the catch:
Banks need retail traders to lose in order to profit.
Forex is a zero-sum game, after all.
When the majority of traders are entering trades in the same direction, the banks' profit potential dwindles - fewer traders are on the losing side for the banks to profit from.
So, how do the banks respond?
Shake out retail traders by triggering a deep retracement or a prolonged consolidation.
As the current downtrend intensifies, most retail traders are jumping on the bandwagon and taking short positions. Trend-following behavior like this poses a problem for the banks, whose profits
are dwindling.
Remember: Banks can only profit when others lose.
To counteract this, banks employ a clever tactic: they shake out these trend-following traders by initiating a consolidation or retracement. If price retraces significantly or enters a period of sideways movement, many short traders will close their losing trades.
This action inadvertently fuels an upward price movement, attracting even more traders who now believe a new uptrend is underway.
Price continues to rise until the banks can re-enter the market at a more favorable price for their sell trades.
Key takeaway:
To trigger a retracement or consolidation, the banks must first take some profits from their existing short positions.
Anticipating a substantial retracement could breach nearby supply zones, the banks strategically exit any trades initiated to create these zones, protecting them from potential losses while simultaneously weakening the zones. With no vested interest in these zones anymore,
banks allow price to break through once it returns.
Let's take a look at a real-world example...
This explains why zones created late into a swing rarely lead to significant reversals: the banks have already exhausted their potential for entering new trades!
To protect themselves from the impending retracement or consolidation, they close out their existing positions, weakening the zone's potential for a strong reversal.
Key Takeaway:
Analyzing the success rate of late-swing zones reveals a clear pattern of underperformance.
But there's more to this than meets the eye...
Notice how the banks' actions are interconnected?
It's a calculated game.
To regain profitability, the banks need the price to rise, which requires shaking out those who entered short positions late in the swing. Their strategy? Take profits from their own short positions, which necessitates a large number of traders selling.
Here's the catch:
Banks can only take profits when the majority of traders are already selling.
It's a trap!
Remember the golden rule: "What the banks can and can't do depends entirely upon how many retail traders are doing the opposite."
The Actionable Insight:
Be cautious of zones forming late in a swing.
Prioritize zones created during the early and middle phases of a swing or trend, especially those with a long preceding move.
While some late-swing zones might still trigger reversals, the probability is lower. Always seek additional confirmation, such as a large engulfing candle or a steep move away, before entering a trade based on these zones.
Remember: Banks are playing a strategic game.
They create numerous zones, hoping to lure in unsuspecting traders.
By understanding their tactics, you can avoid falling into their traps and instead, use their actions to your advantage.