Obligatory disclaimer:
I do not provide personal investment advice and I am not a qualified licensed investment advisor. All information found here is for entertainment or educational purposes only and should not be construed as personal investment advice.
Market structure — an introduction
The same as it is with different trading styles gaining and losing popularity over time people like to use buzzwords like liquidity and market structure without actually knowing what it means.
In this article I’ll be focusing on the widely used terminology “market structure”.
In its core it’s very simple and correlates with the term trend but as it is with everything. It’s easy to understand the core principles but hard to master the subtle differences in a live market.
And before you ask what timeframe I have chosen for my live examples — the timeframe does not matter. There can be trends within trends within trends. The higher the timeframe the better and stronger the trend obviously but the basic characteristics of a trend can be applied on any timeframe.
Let’s start with the basics:
Market structure consists of three different types of trends.
- Uptrends
- Downtrends
- Sideways/consolidation
Each subsequent trend and even the trendless sideways movement have specific characteristics.
For understanding market structure and ultimately what a break in market structure means and looks like first we have to understand what the specific signs of each trend are.
The uptrend:
An uptrend consists of higher lows (HL) and higher highs (HH).
The downtrend:
A downtrend’s characteristics are lower lows (LL) and lower highs (LH).
The sideways market:
A consolidating market does neither of the above mentioned until supply and demand are out of balance and price breaks out. Note, a breakout can occur either to the upside or to the downside depending on where price is in correlation to the overall market situation.
Things you can ask yourself when looking at a chart:
- What is the preceding trend ?
- Where is price ? Is it at support or resistance ?
- What is the overall higher timeframe trend ?
It’s very important to be aware of:
Consolidations can take place at bottoms and at tops. They are not a specific sign of a bottom formation!
And at last a very special type of trend — the parabolic advance:
People might believe a parabolic move is only limited to crypto, but it is not.
Throughout every asset class you can see some sort of parabolic advance on all timeframes even on intraday timeframes.
A parabolic advance doesn’t or at least gives you little to no chance to get onboard on a pullback while price moves fast and strongly upward and usually consists of subsequent bullish candles with little to now retracement and is driven purely by greed. A break of that parabola leads to a break in market structure and the speculative driven fast ascent comes to a halt.
Now we have established a basic understanding of what trends can look like and what they consist of. It’s time to move one step forward.
The Swings
There are two types of swings:
- The swing high (SWH)
- The swing low (SWL)
The swing high:
A swing high is a failure to close above a certain level and hence a sign of exhaustion for in this case bulls to push price further higher.
The swing low:
The same thing applies to a swing low but vice versa where bears fail to push price further lower and subsequently bulls take over control.
It’s important to keep in mind — Swings take place at significant levels which you must find on the left on your chart.
Why is this important?
Because these are the places where a break in market structure can occur.
If a low or a high has been violated by a candle close below or above depending on the situation it implies a shift or continuation of the ongoing trend.
Now you can see why it’s important to understand the basic characteristics of a trend.
A word of caution:
Higher lows in an overall downtrend mean nothing if price fails to accomplish a higher high.
How does a break in market structure now look like ?
In order to understand what a break in MS looks like we have to understand first what an engulfing of a level looks like and what it means.
There are two types of engulfings:
- The bullish engulfing
- The bearish engulfing
A bullish engulfing is when the body of an up candle completely engulfes either the body of its prior candle or a certain resistance level.
A bearish engulfing is when the body of a down candle completely engulfes either the body of its prior candle or a certain support level.
From theory to practice:
The bullish engulfing
The bearish engulfing
As we now have established a basic understanding of what engulfing means we can now move forward onto this article’s final topic:
The break in market structure
Here is a very simplistic and theoretical approach to depict a violation of a trend and hence leading into a break in MS at the top of an uptrend:
As usual, theory first — break in market structure at the bottom of a downtrend:
In the end do you understand why it is important to keep an eye on the trend ?
Because the trend is your friend until it isn’t !
Use the trend to your advantage. There is money to be made both ways and you can easier spot the shift of a trend and hence change your directional bias quicker this way if you pay attention to what the market is telling you.
Thank you for reading and I hope you found some value in my very first article. Remember to backtest any approach first by papertrading.
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