Many traders do not possess sufficient knowledge in order to understand how market trends are formed on the FX market. The goal of today’s article will be the demonstration of how to achieve a deeper understanding of trends through studying the intricacies of trader’s psychological behavior.
To begin with, we will look at the three phases distinctive in all trends, and then have a closer look at the unseen processes which are the reasons behinds these market movements.
Every trend in Forex has three phases.
Note: In our understanding, a trend is the movement of price from one point to another, without a significant fallback in direction.
Phase #1 – Imbalance
The first phase of all market trends is formed due to the existence of a large volume of same type orders, the amount of which is significantly higher than the number of preexisting orders. Such a phenomenon is the very cause behind the appearance of a trend.
If the EUR/USD pair is trending upwards, this means that the overall number of order to buy is higher than the number of sell orders. In order for the market to reverse and start moving downwards, traders have to create a volume of sell orders that will exceed the volume of existing buy orders, which are currently moving the market upwards.
If as a result, the market will contain a sufficient amount of sell orders, they will cover the demand of all buyers, and the market will no longer be able to move upwards, and will start to slowly progress in the downwards direction, as sell order volume increases.
Note: The imbalance phase starts at the origin of all market trends, regardless of the time when one or another trend appears.
Phase #2 – Liquidation
The term called “liquidation” is typically used to describe the situation where a trader closes out a losing trade. Usually, this happens when the market reaches his stop loss level, however many cases feature closing of trades manually, due to market and other reasons.
The liquidation phase is the direct result of imbalance which appears during the first phase. The market movement that is caused by market imbalance during phase 1, forces traders that had open positions directed against the current development of imbalance to close their trades in order to mitigate potential losses or at breakeven.
Those traders that are closing their losing trades are increasing the number of sell bids, therefore accelerating the downward movement of the market even more so.
Note: The duration of the liquidation phase is completely dependent on the number of those traders, that had open orders directed against the developing imbalance.
Phase #3 – Realization
This phase is the overall result of the market behavior in the first two phases. After the completion of the first and the second phases, the market has already significantly moved upwards, enough for traders to realize the changes and to begin regarding the current movement as a new trend.
Phase #1 always emerges as a result of the volume of one type of orders exceeding significantly the volume of the other order type which are the current trend’s base.
Phase #2 emerges after traders begin to close out their trades at breakeven or stop loss, as a direct result of the imbalance that was created during the first phase.
During phase #3 traders begin to realize, that the events that were observed during the first and the second phases were the cause behind formation of a new trend.
Trends play a vital role in trader’s profits. Without a trend, trading would impossible and senseless, which is why it is very important to understand the process behind the creation of market trends. Such knowledge will not only provide you with profits, but will also help you better understand the right time for opening or closing trades.
And although no one can predict the exact time of trend’s beginning or end, the understanding of how and why they form can be quite useful when analyzing the market.
If we could understand how different traders interact with the market when closing or opening trades, we could then be able to determine the moments when banks could open their trades; anyone who is not a novice in Forex trading could confirm that understanding when banks will enter the market is the key to securing profitable trades in numerous cases.