How To Read Market Structures In Forex

The article is authored by Ivan Delgado, decade-long FX Trader. Join thousands of traders who follow Ivan’s insights via Yoututbe & FREE course to increase profitability by learning how to read and trade financial markets. Make sure you also join our Discord room if you’d like to interact with Ivan. Also, find out why Global Prime, the broker Ivan trades with, is the highest-rated.

If interested to watch a Youtube video specifically prepared to complement the teachings of this article, you can access the presentation via this link.

Trading successfully in the forex market is a skill-oriented endeavor, and among the key elements that as a trader you must absolutely possess is the art of picking low-risk entries. To accurately pick these pristine areas of interest, you must first find order within the chaos, in other words, you must develop a blueprint to interpret what the charts are communicating or you risk being lost in an ever ending unstructured mess when reading price fluctuations.

It’s every traders’ aim to make a sensible judgment call to maximize the number of times one picks the right side of the market, isn’t that true? We then must combine it with a high enough risk-reward to enter what I call ‘the sweet spot’ in trading. In simple terms, that’s our jobs as traders, therefore, it’s plausible to think that discerning the dominant cycle should come high on the list as a major piece of the puzzle before you engage in a trade, right?

In this tutorial, I will walk you through how to read these cycles, which go by the name of “market structure”. My mission would be to provide a frame of reference for you to properly interpret the ever-evolving ebbs and flows under any market condition. For some traders, this guide will be enlightening, while to others it may not tick. Remember, this is just one angle to analyze the market, and by no means the only one, but it serves the purpose of providing that much-needed structure in an otherwise chaotic context.

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. If you respect this model of reading the charts, I can assure you that you will be ticking yet another critical box when it comes to developing a solid analytical expertise when trading. As a result, it will allow you to pick locations to trade off for a low risk and potentially high reward.

The ABCs Of Market Structure

Minimum Of Two Closes Beyond Last High/Low

Don’t Lose Sight Of The Forest For The Trees

Personally, I 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.

As I illustrate below, notice how all timeframes in the EUR/USD align with the down-cycle? Wouldn’t you think that trading in a context endorsed by traders from higher time frames adds to your odds of picking the direction the market is most likely to head to in your trading timeframe?

A mechanical rule to apply is the following: If the price in the timeframe immediately above your trading timeframe (the H4 or Daily if trading H1) reaches the 50% Fibonacci retracement of the last valid swing, the position should not be in conflict of the direction of the higher timeframe.

Developing Rules to Validate Cycles

As a general rule, if a swing low/high doesn’t make it to at least the 50% retracement of its previous swing, you 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? The lack of bounce should be a testament that communicates poor buy-side flows. We only want to focus on the creation of relevant and valid legs that will lead to new cycles and create in the process relevant levels of supports and resistances.

A nuance to apply includes the following premise: If the bounce or pullback from the last valid low or high is greater than the average daily range (if trading the hourly) or 3 times the average daily range (if trading the daily), we will also have the pre-conditions to validate the last swing.

Trendlines: A Visual Representation Of The Cycles

Transitions: From Trends To Ranges

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

Velocity Of The Cycle

Projection: Targets In A New Cycle

In the case of the EUR/USD, notice how the target at 1.1510 was reached almost to the pip before sellers took profit? As the market structure stands, upon a breakout confirmation of the range, the first target should come at 1.1419, while a breakout and confirmation of a new cycle low by two closes sub 1.1467 suggests a larger projected target of 1.1430, which would come within striking distance of the target 1.1355 based on the range breakout. I’ve drawn in a red rectangle where these targets come at. It is at these levels where one should expect a potential exhaustion of the downward cycle.

Cluster Of Levels Nearby

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). Below you can find an example in the EUR/USD, where I’ve drawn the two most immediate levels of support and resistance in the daily and H4. What this means is that if you are going to find trades off the H1 chart, you must be aware that once the price reaches these areas in the higher time frames, a potential disturbance of the structure in your trading time frame (H1 in our example) may occur, hence you must be prepared by anticipating this potential outcome. The mark up of levels in your chart allows you to do precisely that, to expect a potential turnaround.

Additionally, the clusters of levels from your trading timeframe must also be marked. If you’ve followed me this far, you will by now understand that a new cycle would be confirmed if we can break and have two hourly closes outside the range, right? However, what if we break the current range but we are faced with another recent low immediately ahead as in the case of the EUR/USD (example below) at 1.1465? If the distance is relatively narrow — about 15/20 pips in the EUR/USD — a safer approach is to wait until a breakout of the most distant level in that cluster of support areas, which would be two closes beyond 1.1465 to confirm the down cycle. Essentially, when this situation occurs, what you probably want to do is to expand the size of the range by that extra 15–20 pips and wait for a resolution outside. Note, the 15–20p in the EUR/USD is just a personal preference. You can work out your own personal magic range based on the ADR of the pairs you are trading.

How To Trade Market Cycles

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 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.

Examples/

How To Trade Ranges

Conclusion

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.

Extra Bonus (Practical Exercise)

Additional Articles By The Author

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