The Reality of All Markets

There is a strong reason why 95% of traders lose money. So, what can you do to avoid being part of that statistic? Hopefully, this piece of article will put you on the right path of becoming part of the small 5% group of traders who are successful in this business. The harsh truth is that the majority of market participants fail at trading because of two important things:

  1. A lack of understanding how the market really operates.
  2. A lack of understanding of what happens behind the scene – behind the price action.

There is a reality of the market behind of what is visible to us. We tend to focus our attention too much on the price action or on technical indicators forgetting the things that really matters. The things happening behind the scene – we call the scene the price because that’s what it’s visible to us –  more important than the price action. Understanding the reality behind the price, which ultimately means understanding how the markets operates, should be your main goal if you want to really succeed in the financial world.

In this new reality of how the markets really operate, we can discern the fact that not technicals or fundamentals drive the price up and down but there is something much deeper going behind the scene.

This brings us to an important topic: a price chart is not everything there is about the nature of the market. There is another hidden order beyond the price chart that actually drives the market up and down.

“A picture (a chart) speaks a thousand words” is an old aphorism that speaks a lot of truth but unfortunately not the whole truth. To really understand what makes a price pattern to work, we really need to understand the market forces behind the price chart.

What are the forces behind a price chart?

In simple terms, the interaction between traders placing buy and sell orders is the real force that drives the price. In other words, this is what we call the order flow. Understanding the order flow will give you a better understanding on how the market really works.   

Sometimes the obvious doesn’t seem so obvious, so we feel the need to emphasize the fact that the price action is the effect and the order flow is the cause that makes price move. Unfortunately, the center of attention of the majority of traders is on the price (the Effect) and not on the order flow (the Cause).

Understanding the cause behind any price movement will help you better anticipate and forecast future trade setups. Not just that, but having an order flow mindset will help you enter a trade earlier than most traders. Knowing the real reason behind why price moves will give you more confidence in executing your trades which means that you’re no longer going to be at the mercy of the markets.

Trading purely on the price action (the Effect) it means that you’ll be late to the party because the forces (the Cause) that put in motion the price action has already occurred. It also means that you’ll be buying and selling long after the price was put in motion and you’ll depend on other traders to join the party and push the market in your direction.

Let’s move forward, and disseminate the Head and Shoulder reversal pattern and see how different types of traders would trade this pattern, in comparison with a trader that has an order flow mindset.  

In the figure below, we have a typical example of a Head and Shoulder pattern. After analyzing the price pattern we can discern several possible trade scenarios that are related to different trading styles and to different level of experience.

The breakout traders alongside price action traders would have entered a short position at point number 2, where a range breakout happens and the Head and Shoulder neckline is broken at the same time.  

If we speak about more conservative traders, they would probably enter in the vicinity of number 3 after the breakout is confirmed by the candlestick closing below it. The indicator based traders would have entered at an even worse price due to the indicators’ lagging behavior. The longer you delay your entry point, your profit margin decreases substantially, making it hard to profit from the move.

Alternatively, if you would have adopted the order flow mindset and would have based your entry on the “Cause” behind the price movement you could have entered in the vicinity of number 1 and possibly ride the entire down move until near number 4.   

Did you ever wonder what makes a Head and Shoulder pattern, or for that matter any kind of price pattern?

The answer to this question is traders executing orders, which at the end of the day is what drives any market up and down. It’s the interaction between the buy orders and sell orders.

Reading and interpreting what other market participants are doing is not an easy job and it requires a lot of experience and practice. You should never enter a trade unless your reading of the Cause behind the price is clear.

The reality of all markets is behind the scene and it’s not something visual that can be seen on the price chart, it’s more a mindset. If it’s something that can’t be seen, and you don’t know about it, then you won’t search for it, and you will be trading for the rest of your live only based on the Effect aka the price action. It’s what you’re not able to see – the Cause – what makes all the difference between success and failure.

The interaction between buy and sell orders, or in other words the supply and demand imbalances is the reality behind the scene and it’s the reality that matters the most. Once you understand the game behind the price action a new reality will be accessible to you.

Thank you for reading!

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Alexflores

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