Let's talk about the elephant in the room:
The concept of 'trend.'
I know this might ruffle some feathers because most traders are deeply ingrained with a certain understanding of what a trend is. However, as we continue, you'll discover why your current perception of 'trend' might be setting you up for losses.
Before we move on, ponder this question:
When does a price movement officially become a trend?
Or are all movements, in essence, trends at different scales?
Keep this question in the back of your mind as you read, because it's a crucial concept to grasp to understand how trends form.
So, how do we define a trend?
Using LRC's (Large Range Candlesticks!)
Any candlestick demonstrating a significant price change is considered a Large Range Candlestick.
LRCs are the driving force behind every uptrend and downtrend, as they signal substantial price shifts and are essential for understanding market direction. They play a crucial role in shaping
how traders both perceive the market's movements and make decisions.
But for now, let's shift to a key psychological aspect of LRCs:
FOMO (fear of missing out).
The FOMO Effect:
When retail traders encounter a large range candlestick, they often impulsively jump on the bandwagon, following the candlestick's direction without a second thought.
It's a knee-jerk reaction fueled by emotion:
Urgency: Traders feel pressured to act quickly before the perceived opportunity disappears.
Fear: Traders worry about missing out on potential profits if they hesitate.
This behavior isn't based on any sophisticated strategy.
It's pure, unadulterated emotion driving their decisions.
The size of the LRC amplifies this fear.
The larger the candle, the more convinced traders become about the market's direction. News events, especially high impact economic news, where large range candles often coincide with
high volume as reactive traders rush in.
Let's take a closer look...
Steep moves are a magnet for reactive traders, who interpret them as golden trading opportunities they can't miss (FOMO again!). It's easy to see why - in each instance, it appears the market is surging higher or lower.
But right after these movements, the market usually stalls or zips in the opposite direction. Almost like a cunning trap laid by the banks to trip up these reactive traders.
Here’s another one:
Check out the massive up-move on the far right of the chart. It's undeniably bullish and difficult to ignore, wouldn't you agree?
Many traders would likely have been tempted to jump in with buy orders, expecting the price to keep climbing.
What would you have done in this situation?
Let's see how this scenario actually played out...
The sudden upward surge acts as a magnet for reactive traders, who pile into long positions, driven by FOMO.
This creates the perfect opportunity for banks to capitalize on the buying frenzy and take profits off their own long trades. The consequence?
Price plummets, leaving those impulsive traders with losses.
Sound familiar?
This is a classic "bull trap," and it's not limited to a specific timeframe.
Whether you're analyzing a 1-hour chart or any other timeframe, you'll encounter these steep, tempting moves filled with large range candles. Underlying psychological triggers – greed and fear – remain consistent across all timeframes, luring in unsuspecting traders and creating opportunities for the banks to profit.
Now, we'll uncover the three fundamental phases that underpin every trending movement in the market.
We'll start by defining these phases and their roles, then we'll explore real-world examples to solidify your understanding.
Here's the key takeaway:
Every trend is composed of three distinct phases.
These phases unfold sequentially, like clockwork, shaping the price movements and trends we see on our charts.
My Definition of a Trend:
For the purpose of this discussion, I define a trend as a sustained price movement from one point to another without significant pullbacks or consolidation. We're focusing on shorter-term trends, rather than extended movements on higher timeframes, like the weekly or monthly charts.
Let's dive into the three phases, starting with the most critical...
Phase 1: Imbalance
The imbalance phase is the spark that ignites all major market movements.
It's aptly named because a change in price direction can only occur when a significant imbalance of orders enters the market.
Here's how it works:
Imagine a scenario where the market is trending downwards.
For price to reverse and start rising, buy orders larger than the current sell orders must flood the market. This influx of buying power creates an imbalance, tipping the scales in favor of the bulls and propelling price upwards.
Let's illustrate this with an example:
For the EUR/USD to reverse and start climbing, a significant influx of buy orders, surpassing the current sell orders, was necessary.
But where did this wave of buying come from?
In this scenario, the driving force was the banks.
They entered the market with substantial buying power, absorbing the available sell orders and pushing the price upward.
This creates what we call an imbalance:
The demand (buy orders) significantly outweighs the supply (sell orders).
Whenever you see a shift in price direction, it's due to this imbalance phase kicking into gear. It's the catalyst for all major market movements, regardless of the timeframe or currency pair you're analyzing.
Phase 2: Liquidation
The liquidation phase is the aftermath of the imbalance created in the first phase.
During the imbalance, a flood of orders enters the market, overwhelming the orders that were previously driving the price in the opposite direction.
This is the spark that ignites the initial movement in every price reversal.
As price starts moving in the new direction, traders who were positioned against this reversal begin to panic. Stop losses get triggered, forcing them to close their losing trades. The cascade
of forced exits further accelerates the price movement in the direction of the reversal.
Let's revisit our example to see how this plays out:
Let's recall the EUR/USD example from earlier, where the banks triggered a reversal by buying heavily.
During the initial imbalance phase (the sudden surge higher), many traders opened short positions, anticipating the price would continue falling. However, as the banks persisted in buying, the price reversed, catching these traders off guard.
Their stop losses, placed just above the swing high, were triggered as the price climbed, forcing them to close their short positions at a loss.
To close a short trade:
You must buy back the currency you initially sold.
This wave of forced buying further fueled the upward momentum, pushing the price even higher.
The core of the liquidation phase: traders closing losing positions amplify the initial price movement caused by the imbalance. It's a chain reaction, with each trader's forced buying propelling the price further upwards.
Phase 3: Awareness
As price continues to climb, more and more traders jump on the bullish bandwagon, assuming the upward momentum will continue.
The appearance of bullish large range candles reinforces this belief, further fueling the buying frenzy. Since more traders pile into buy trades, the gap between buy orders and sell orders
widens, amplifying the imbalance in the market.
Now the banks can make their move.
They have two options:
Take Profits and Reposition: Common in extended trends, where the banks secure a portion of their profits and then reposition themselves for the next leg of the move.
Close Trades and Initiate a Reversal: What we see happen in our example, where the banks close their buy positions, triggering a reversal.
Understanding this dynamic is crucial for anticipating potential reversals and avoiding getting caught on the wrong side of the market.
Quick Recap: The Three Phases of a Trend
Phase 1: Imbalance: The initial spark that sets the trend in motion. A large influx of orders overwhelms the existing market direction, causing a reversal.
Phase 2: Liquidation: The fuel that propels the trend. Traders caught on the wrong side of the initial reversal are forced to close their positions, accelerating the price movement.
Phase 3: Awareness: The trend becomes apparent. As price continues to move, more traders recognize the new trend and jump on board, further fueling the momentum.
Take a look at the image.
Imagine you're trying to predict the market's next move.
Does it scream "major reversal" to you?
Probably not.
But why?
Price hasn't fallen far enough to convince you that a new downtrend is underway. There's no new lower low (marked with an 'X'), and recent price action has been bullish - a rally or a period of consolidation still seem plausible.
Here's a fundamental truth:
No one truly perceives a trend until the market has moved significantly enough in one direction to confirm its existence.
Remember the question from the beginning?
"At what point does a movement become a trend? Or are all movements inherently trends?"
All price movements from A - B are technically trends, but not every trader recognizes them as such at the same time.
Different Timeframes, Different Perspectives
Any trader on a 5-minute chart has a vastly different perspective than a trader on a daily chart. Time horizons and trading strategies differ significantly. The divergence in perspective means what one trader considers a trend, another might see as a mere blip - a sustained decline on
a 5-minute chart could only appear as a minor fluctuation on the daily chart.
Interestingly, the actions of traders on shorter timeframes can influence the perceptions of those on longer timeframes.
If enough traders on the 5-minute chart sell, it can trigger a cascade effect, causing traders on higher timeframes to reconsider their positions and potentially join the selling pressure.
For example:
A strong downtrend on the 5-minute chart could lead to losses for 1-hour chart traders, prompting them to close their long positions. This increased selling pressure could then trigger a larger move that attracts daily chart traders to the short side, further fueling the downward momentum.
IMPORTANT: The concept of a "trend" is relative to the timeframe you're analyzing.
A substantial trend on one timeframe might be insignificant on another.
Understanding this can help you avoid getting caught up in the hype of short-term movements and focus on the bigger picture.
Before the downtrend kicked off on EUR/USD, most orders entering the market were buys.
Why so?
The initial downward move from the 1.39 high was perceived as a downtrend only by a subset of traders, mainly those operating on lower timeframes like the 15-minute and 1-hour charts.
Most traders on daily and weekly charts wouldn't consider this a new downtrend yet because the price hadn't fallen far enough for them to perceive a new trend. Traders on longer timeframes also probably hadn't closed their losing trades when the initial downward move from the 1.39 high.
The longer time horizon higher risk tolerance means longer term traders reacts differently to price action compared to a 1-hour trader.
Bottom Line:
Banks actually benefit from retail traders misinterpreting the market and entering trades based on FOMO or the illusion of a continuing trend. It's a game of cat and mouse, where the banks need the "mice" (retail traders) to keep playing in order to win!