Imagine a carpenter who constructs a beautiful chair intended for people that weigh 50 kg. But If anyone that weigh 50kg or less sits on it. The chair collapses.
Or a beautiful table intended to withstand a maximum weight of 50kg. But if an object is placed on it, a weight 45kg or less. The table still collapses.
That means, the carpenter is getting something wrong. Either he is not considering the strength of the material he used for the construction or he lacks the basic skills of carpentry.
This concept applies to trend trading too. Nobody is happy with a beautiful strategy or concept unless proven profitable or workable. A lot of beginner traders find it difficult to read market structure because they lack the initiative on how the market moves.
They use indicators wrongly. Indicators work in different market environments. Sometimes the market may be trending or ranging or the market may be in a volatile phase. Traders read the structure/situation wrongly using these indicators. They enter the market with wrong analysis and end up blowing their account.
You don’t want to be like the carpenter from the example above who don’t understand the principles of good carpentry. As a trader, it is important to understand the principles of market structure and behavior.
The price action way.
The financial market does not move in a straight path. It moves in a wave like manner forming peaks. These peaks are turning points referred to as highs and lows. Price action traders use these highs and lows to tell what the market is doing at any given time.
From figure a above
The yellow region represents the HIGHS
The light blue region represents the LOWS
Trending markets is a herd movement in the market place. This market can either be an uptrend or a downtrend. There are different ways to trade a trending market.
As I wrote above. The market moves in a wave like manner. It could be up, down, range or randomly. A market that moves upward is referred to as an uptrend forming higher highs(HH) and higher lows(HL).
If you do not understand what that means. Here is a sketch below.
When price breaks above the previous High(H), the new HIGH is referred to as a Higher High(HH). Alongside, when price breaks above the previous Low(L), a Higher Low(HL) is formed.
A down-trending market works the same way with an uptrend but moves in a reverse manner. In a downtrend the market makes lower lows and lower highs. Here is a sketch of a downtrend below.
When price breaks below the previous low(L), the new Low is referred to as a Lower Low(LL). Alongside, when price breaks below the previous High(H), a Lower High(LH) is formed.
Reading market structure.
Now you know what a trending market means understanding how to read market structure is necessary. Take a look at the sketch below.
Price breaks H1, makes a new low(L2) at the previous high(H1).
Price continues, breaks H2, makes a new low(L3) at former high(H2).
Price does not break H3
The price moves lower and breaks the low(L3). At the break lower, the uptrend has transitioned into a downtrend making lower lows and lower highs. The previous highs and lows serve as support and resistance.
A volatile market.
Volatility, trend traders worst enemy. A lot of beginner traders get confused in a volatile market thereby causing wrong analysis and bad trades.
In a volatile market, the market is neither in an uptrend or a downtrend. The market is directionless. There are quick market reversals in the market.
The market making higher high and higher low, instead of continuing higher it reverses making a lower low and reverses again. The movement is a random movement. Most times, it becomes difficult to trade.
Figure g and h shows charts of a volatile market.