EUR/USD: How To Trade Market Structures
EUR/USD: How To Trade Market StructuresAuthored by Ivan Delgado, Head of Market Research at Global Prime. This educational post has been exclusively adapted for tradingview users.
In this tutorial, I walk you through how to read these cycles, which go by the name of “market structure”. You will be provided a frame of reference for you to properly interpret the ever-evolving ebbs and flows under any market condition. You will be able to approach the charts in a mechanical way to constantly be in tune with the right context at play, which in its simplest form, comes down to trade trends or ranges.
Minimum Of Two Closes Beyond Last High/Low: To confirm that a bearish trend or down-cycle is evolving in a healthy manner, not only we need to see the low printed being lower than its previous low, but we also should expect at least two closes beyond that low or support area as further evidence that the market is accepting and building value. Failure to print at least two closes may be a precursor to what’s often referred as head-fake or false breakout, and while the move still holds its merit to qualify as a new low in the cycle, the quality of the leg is poor in nature.
Don’t Lose Sight Of The Forest For The Trees: While in this exercise we don't provide higher timeframe charts to keep it clean, you must, by all means, avoid the trap of being short-sighted by only sticking to one chart analysis. When conducting your market structure studies, it’s all about building a thesis about a particular direction by finding concurrence from higher time frames down to your trading time frame. We wouldn’t recommend using more than 3 charts as your reference or you may suffer from so-called “analysis paralysis”. What this means is that if you are going to find an entry trigger off the hourly, you should then understand what type of conditions are dominant in the immediately higher time frames. The most popular in this case would be the 4h and daily charts.
Developing Rules to Validate Swing Lows/Highs: This is a key point that often gets overlooked by market participants by letting too much guessing play a role. When analyzing the charts, how do we determine what constitutes a relevant swing high/low? We need to find a mechanical approach that will allow us to qualify what we understand by relevant swing highs or swing lows in the chart. As a general rule, if a swing low/high doesn’t make it to at least the 50% retracement of its previous swing, you probably want to disregard that price movement as not relevant enough to constitute a valid leg. After all, why would you want to consider a leg that originates from a low which doesn’t even make it to the 50% retracement as a point of interest relevant enough?
Trendlines: A Visual Representation Of The Cycles: This is another rule to incorporate. If on a downtrend we make a higher high as in the case of the EUR/USD, but this high fails to break the descending trendline, be extremely cautious as more often than not, it can easily lead to a quick reversal in line with the dominant cycle. The power of a trendline lies not only in its capacity to provide an entry trigger but as a blueprint to help you understand the type of dominant market flows and potential locations to engage upon your own models. In the chart, I've drawn the most obvious ones. Always pay special attention on a 3rd touch of a trendlines, which is the time when it tends to hold the most weight.
Transitions: From Trends To Ranges: We’ve come to the point in the market structure where the dominant flows start drying up due to increased profit-taking, change in ebbs and flows due to removals of liquidity, intervention by market-makers, economic data-driven moves, etc. While in a down-cycle, the interpretation of the chart is straightforward, when is it that we can say with certainty that we’ve transitioned from a trend into a consolidation? In the case of the EUR/USD hourly chart, firstly, we must see a failed test of a valid low (Oct 5th). Secondly, a recovery above the 50% fib retracement of the most recent swing high would confirm that we have entered a consolidation phase, which would last until the most recent valid high or low is broken, with at least two closes above/below the level. In this context, don’t forget that the consolidation is within the context of a down-cycle not only in the higher time frames but also on the hourly. Until buyers manage to break and hold above the latest valid swing high, which doesn’t occur, the risk remains to the downside.
Magnitude Of The Cycle: Another major clue that will help us determine the health of the cycle is the type of progress made by the dominant side in control of the cycle. In this section of the analysis, we need to ask the following question: Are the new legs in the cycle increasing or decreasing in magnitude? The latest swing lows in EUR/USD, if we were to measure its extension from the last high to the newly established low, saw a slide worth 128 pips vs the previous leg down, which only achieved a move of 120 pips. This carries an important message: The most recent flows communicate that sellers are increasing its commitment on each new cycle low (greater supply imbalances), therefore, this is yet another clue that the risk should stay skewed to the downside.
Velocity Of The Cycle: When it comes to the distance the price moves, the magnitude is only ½ the equation. The other ½ has to do with the velocity of the move or the speed. Was the new leg created after a fast and impulsive move? Or did price make a new low or high with the movement being sluggish, compressive and taking too long to form? A good rule of thumb is to count the number of candles it took to achieve a new leg. In the illustration, you can see how it took 21 hourly bars to achieve 120 pips vs 18 bars to net 128 pips. Bottom line: Before the rebound seen yesterday, the cycle continues to prosper in a healthy manner.
Levels : You shoud mark lines of support and resistance based on higher timeframes. They should be obvious to spot. The considerations to be given when selecting these areas include the number of times the area has been tested (minimum of 2 times), type of reaction away from this area (the stronger the more relevant), time frame (the higher the timeframe the more significant the level is).
Projection: Targets In A New Cycle: By far, the most accurate measure I have found to set targets (partial or full take profits) when trading cycles is to measure the 100% fibonacci projection from the most recent valid swing high to its low. Note, there will be enough cases when events outside one’s control will cause prices to fluctuate erratically and not achieve these targets. Don’t forget to also factor in potential hurdles in the form of higher time frame support/resistance areas. You should see these levels as simple guides but far from certain outcomes. If the cycle continues in the expected direction, you will start to appreciate the power and usefulness of these targets to consider taking profits or trailing stops in hope of an ever larger yield in your trade. In the case of the EUR/USD, notice how downward targets (on a sequence of 100% fib proj) were reached almost to the pip of the way down? With the price having reached its 400% fib proj, it suggests a potential recovery near term.
How To Trade Market Cycles: The real power lies in the congruence of factors from a top-down approach, aiming to have as many aligning in your favor as possible. In the example of the EUR/USD exercise, the recent down cycle in the hourly had the backing of the H4 and daily cycles as well, which undoubtedly reinforces the chances of picking the right direction to trade. Now, does this mean that the bearish market structure in the hourly will be respected? Not at all. Remember that each individual trade is just a random event within the context of an exploitable edge. However, by conducting the proper market structure analysis, you do obtain that edge in terms of the location to engage that can offer a relatively low-risk entry for a potentially much larger yield.
So, how can you go about trading these cycles? First and foremost, assuming you are trading off the hourly chart, you want to make sure to trade also in line with at least the immediately higher timeframe cycle (H4), and ideally both (daily and H4). You also want to double-check that the hourly market structure is trending as per the rules of two closes beyond the last valid swing low/high to confirm a new leg in the cycle. It’s important that you then check the absence of nearby cluster levels from higher time frames or economic data releases that may disturb the structure. Next is to make sure that the price remains guided by a descending or ascending trendline. Lastly, and this point is key, pay attention to both the magnitude and the speed on the creation of a new cycle.
As a general rule, regardless of the type of cycle, I personally don’t see enough risk-reward value if one engages ahead of a 50% fib retracement. If we are in a healthy cycle with lower lows, decent magnitude moves and no obstruction of higher timeframe levels, it makes the 50% fib retracement a great location to start looking for trades based on your ideal entry technique. Some traders may prefer to set limit orders at this levels with a stop a few pips away from the most recent high/low (this approach would make the most sense if the underlying trendline is still respected). Others may prefer a confirmation trigger such as the break of a trendline, a particular pattern (pennant, triangle) or a specific price action formation such as engulfing bars, pin bars.
Whichever way you approach your trades, it should nonetheless be from having an inner peace of mind that the area you are looking to trade from holds value on the basis of decent risk-reward prospects. Alternatively, and this is subject to one’s discretion, I personally remain more cautious to enter at the 50% fib retrac and tend to wait for either the 78.6% fib retrac or a test of the previous valid swing low/high in the case that we had a break but we never confirmed the cycle by having two closes past the level. If the cycle is confirmed but the magnitude is nowhere close to what would qualify as healthy, be more cautious trading around the 50% (wait for trigger). Personally, a great pattern I've spotted over the years for a potentially large risk-reward is to be on the lookout to trade a retracement to at least the 78.6% Fibonacci within the context of a strong and healthy cycle. This trades tend to offer the most bang for your buck, even if you must be patient for them to come about.
How To Trade Ranges: When the price starts trading confined in a box or consolidation phase, we know this is a period of reassessment before the next directional move. Unless a breakout occurs, the only area where you really want to engage as part of a range include the upper or lower edge. A useful exercise to conduct every time the price fluctuates within a range is to draw a 50% fib retracement, and start to observe what side of the range the price spends the most time at. Is is the lower half or the higher half? The side where price usually spends the most time tends to be the most vulnerable for a price breakout. See when the EUR/USD entered a range between Sept 21–28? Notice how the attempts to trade above the 50% fib retracement of the range were consistently rejected while price would accept below?
Conclusion: By now you’ve hopefully come to grips about the importance to keep your charts neat and clean, away from unnecessary indicators while embracing the power of reading market structures in a proper way. You have also gained enough knowledge to ultimately, through your own analysis based on a rules-based approach, find these low-risk areas to enter trades. While some degree of subjectivity will always be required, this tutorial offers you a roadmap from which to find the order within the chaos. You must become the primary conductor of your own orchestra as the forex symphony keeps playing. The right interpretation of market cycles will allow you to make sense of the music being played at all possible levels.
In this tutorial, I walk you through how to read these cycles, which go by the name of “market structure”. You will be provided a frame of reference for you to properly interpret the ever-evolving ebbs and flows under any market condition. You will be able to approach the charts in a mechanical way to constantly be in tune with the right context at play, which in its simplest form, comes down to trade trends or ranges.
Minimum Of Two Closes Beyond Last High/Low: To confirm that a bearish trend or down-cycle is evolving in a healthy manner, not only we need to see the low printed being lower than its previous low, but we also should expect at least two closes beyond that low or support area as further evidence that the market is accepting and building value. Failure to print at least two closes may be a precursor to what’s often referred as head-fake or false breakout, and while the move still holds its merit to qualify as a new low in the cycle, the quality of the leg is poor in nature.
Don’t Lose Sight Of The Forest For The Trees: While in this exercise we don't provide higher timeframe charts to keep it clean, you must, by all means, avoid the trap of being short-sighted by only sticking to one chart analysis. When conducting your market structure studies, it’s all about building a thesis about a particular direction by finding concurrence from higher time frames down to your trading time frame. We wouldn’t recommend using more than 3 charts as your reference or you may suffer from so-called “analysis paralysis”. What this means is that if you are going to find an entry trigger off the hourly, you should then understand what type of conditions are dominant in the immediately higher time frames. The most popular in this case would be the 4h and daily charts.
Developing Rules to Validate Swing Lows/Highs: This is a key point that often gets overlooked by market participants by letting too much guessing play a role. When analyzing the charts, how do we determine what constitutes a relevant swing high/low? We need to find a mechanical approach that will allow us to qualify what we understand by relevant swing highs or swing lows in the chart. As a general rule, if a swing low/high doesn’t make it to at least the 50% retracement of its previous swing, you probably want to disregard that price movement as not relevant enough to constitute a valid leg. After all, why would you want to consider a leg that originates from a low which doesn’t even make it to the 50% retracement as a point of interest relevant enough?
Trendlines: A Visual Representation Of The Cycles: This is another rule to incorporate. If on a downtrend we make a higher high as in the case of the EUR/USD, but this high fails to break the descending trendline, be extremely cautious as more often than not, it can easily lead to a quick reversal in line with the dominant cycle. The power of a trendline lies not only in its capacity to provide an entry trigger but as a blueprint to help you understand the type of dominant market flows and potential locations to engage upon your own models. In the chart, I've drawn the most obvious ones. Always pay special attention on a 3rd touch of a trendlines, which is the time when it tends to hold the most weight.
Transitions: From Trends To Ranges: We’ve come to the point in the market structure where the dominant flows start drying up due to increased profit-taking, change in ebbs and flows due to removals of liquidity, intervention by market-makers, economic data-driven moves, etc. While in a down-cycle, the interpretation of the chart is straightforward, when is it that we can say with certainty that we’ve transitioned from a trend into a consolidation? In the case of the EUR/USD hourly chart, firstly, we must see a failed test of a valid low (Oct 5th). Secondly, a recovery above the 50% fib retracement of the most recent swing high would confirm that we have entered a consolidation phase, which would last until the most recent valid high or low is broken, with at least two closes above/below the level. In this context, don’t forget that the consolidation is within the context of a down-cycle not only in the higher time frames but also on the hourly. Until buyers manage to break and hold above the latest valid swing high, which doesn’t occur, the risk remains to the downside.
Magnitude Of The Cycle: Another major clue that will help us determine the health of the cycle is the type of progress made by the dominant side in control of the cycle. In this section of the analysis, we need to ask the following question: Are the new legs in the cycle increasing or decreasing in magnitude? The latest swing lows in EUR/USD, if we were to measure its extension from the last high to the newly established low, saw a slide worth 128 pips vs the previous leg down, which only achieved a move of 120 pips. This carries an important message: The most recent flows communicate that sellers are increasing its commitment on each new cycle low (greater supply imbalances), therefore, this is yet another clue that the risk should stay skewed to the downside.
Velocity Of The Cycle: When it comes to the distance the price moves, the magnitude is only ½ the equation. The other ½ has to do with the velocity of the move or the speed. Was the new leg created after a fast and impulsive move? Or did price make a new low or high with the movement being sluggish, compressive and taking too long to form? A good rule of thumb is to count the number of candles it took to achieve a new leg. In the illustration, you can see how it took 21 hourly bars to achieve 120 pips vs 18 bars to net 128 pips. Bottom line: Before the rebound seen yesterday, the cycle continues to prosper in a healthy manner.
Levels : You shoud mark lines of support and resistance based on higher timeframes. They should be obvious to spot. The considerations to be given when selecting these areas include the number of times the area has been tested (minimum of 2 times), type of reaction away from this area (the stronger the more relevant), time frame (the higher the timeframe the more significant the level is).
Projection: Targets In A New Cycle: By far, the most accurate measure I have found to set targets (partial or full take profits) when trading cycles is to measure the 100% fibonacci projection from the most recent valid swing high to its low. Note, there will be enough cases when events outside one’s control will cause prices to fluctuate erratically and not achieve these targets. Don’t forget to also factor in potential hurdles in the form of higher time frame support/resistance areas. You should see these levels as simple guides but far from certain outcomes. If the cycle continues in the expected direction, you will start to appreciate the power and usefulness of these targets to consider taking profits or trailing stops in hope of an ever larger yield in your trade. In the case of the EUR/USD, notice how downward targets (on a sequence of 100% fib proj) were reached almost to the pip of the way down? With the price having reached its 400% fib proj, it suggests a potential recovery near term.
How To Trade Market Cycles: The real power lies in the congruence of factors from a top-down approach, aiming to have as many aligning in your favor as possible. In the example of the EUR/USD exercise, the recent down cycle in the hourly had the backing of the H4 and daily cycles as well, which undoubtedly reinforces the chances of picking the right direction to trade. Now, does this mean that the bearish market structure in the hourly will be respected? Not at all. Remember that each individual trade is just a random event within the context of an exploitable edge. However, by conducting the proper market structure analysis, you do obtain that edge in terms of the location to engage that can offer a relatively low-risk entry for a potentially much larger yield.
So, how can you go about trading these cycles? First and foremost, assuming you are trading off the hourly chart, you want to make sure to trade also in line with at least the immediately higher timeframe cycle (H4), and ideally both (daily and H4). You also want to double-check that the hourly market structure is trending as per the rules of two closes beyond the last valid swing low/high to confirm a new leg in the cycle. It’s important that you then check the absence of nearby cluster levels from higher time frames or economic data releases that may disturb the structure. Next is to make sure that the price remains guided by a descending or ascending trendline. Lastly, and this point is key, pay attention to both the magnitude and the speed on the creation of a new cycle.
As a general rule, regardless of the type of cycle, I personally don’t see enough risk-reward value if one engages ahead of a 50% fib retracement. If we are in a healthy cycle with lower lows, decent magnitude moves and no obstruction of higher timeframe levels, it makes the 50% fib retracement a great location to start looking for trades based on your ideal entry technique. Some traders may prefer to set limit orders at this levels with a stop a few pips away from the most recent high/low (this approach would make the most sense if the underlying trendline is still respected). Others may prefer a confirmation trigger such as the break of a trendline, a particular pattern (pennant, triangle) or a specific price action formation such as engulfing bars, pin bars.
Whichever way you approach your trades, it should nonetheless be from having an inner peace of mind that the area you are looking to trade from holds value on the basis of decent risk-reward prospects. Alternatively, and this is subject to one’s discretion, I personally remain more cautious to enter at the 50% fib retrac and tend to wait for either the 78.6% fib retrac or a test of the previous valid swing low/high in the case that we had a break but we never confirmed the cycle by having two closes past the level. If the cycle is confirmed but the magnitude is nowhere close to what would qualify as healthy, be more cautious trading around the 50% (wait for trigger). Personally, a great pattern I've spotted over the years for a potentially large risk-reward is to be on the lookout to trade a retracement to at least the 78.6% Fibonacci within the context of a strong and healthy cycle. This trades tend to offer the most bang for your buck, even if you must be patient for them to come about.
How To Trade Ranges: When the price starts trading confined in a box or consolidation phase, we know this is a period of reassessment before the next directional move. Unless a breakout occurs, the only area where you really want to engage as part of a range include the upper or lower edge. A useful exercise to conduct every time the price fluctuates within a range is to draw a 50% fib retracement, and start to observe what side of the range the price spends the most time at. Is is the lower half or the higher half? The side where price usually spends the most time tends to be the most vulnerable for a price breakout. See when the EUR/USD entered a range between Sept 21–28? Notice how the attempts to trade above the 50% fib retracement of the range were consistently rejected while price would accept below?
Conclusion: By now you’ve hopefully come to grips about the importance to keep your charts neat and clean, away from unnecessary indicators while embracing the power of reading market structures in a proper way. You have also gained enough knowledge to ultimately, through your own analysis based on a rules-based approach, find these low-risk areas to enter trades. While some degree of subjectivity will always be required, this tutorial offers you a roadmap from which to find the order within the chaos. You must become the primary conductor of your own orchestra as the forex symphony keeps playing. The right interpretation of market cycles will allow you to make sense of the music being played at all possible levels.
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