*Learn the fundamental principle of any market and how capitalise on that!*
A lot of times when a person tries anything new they will look to who the “professionals” are, see what they are doing and try to do the same. This can be detrimental to your journey and will almost certainly suppress your ability to get started and progress at what you are trying to do. Whether you are trying to start trading, playing a new sport or learning a new language you have to build your skill set from the ground up and start with the basics. You need to understand the fundamental principles of the new skill you are trying to learn and then grow from there.
There is no skill that this applies to more than trading the financial markets.
In this post I will talk you through what I (and many others) believe to be the basic principles to any market and what makes the financial markets move. I will then show you how I use this very basic principle to look for trading opportunities. Let’s start with 2 simple words that you should all know: Supply & Demand.
Supply – The total amount of goods or services available for purchase.
Demand – The buyers ability and desire to purchase a good or service at a certain price.
Market Price is determined by the price producers are willing to sell at (normally as high as possible) and the price buyers are willing to buy at (normally as low as possible) with price settling at the middle where these two meet called the equilibrium.
The basic laws of supply and demand are this: if supply increases then price decreases, if demand increases then price increases. This can be represented on the chart above by moving the supply line (S) to the right. This would then mean that the point where supply & demand meet (the equilibrium) would be low down and therefore price is lower. If supply decreases then the opposite happens. If demand increases, then price increases. This is seen on the chart above where D1 moves to D2 (demand shifts to the right) and therefore the equilibrium is moved higher from P1 to P2 representing and increase in price.
Almost all markets are defined by the laws of supply and demand and if you want to learn more about them then click here.
So how does this relate to trading the financial markets? Let me show you.
Firstly, if you haven’t already done so I would suggest you go and read my previous blog post on trading using support and resistance zones. This will help you as you will then understand why support & resistance and supply & demand are linked and how they work in trading. The link to this post is below:
In regards to FX Currencies the way supply & demand effects price is fairly simple. If the value of a currency decreases enough then it will be cheaper and the ability and willingness of buyers to purchase that currency will increase. As demand increases, so does price.
The price of FX Currencies can also be effected massively by supply. Central Banks have the ability to use a tool called Quantitive Easing (QE) which is used to control inflation and keep it inline with their targets. QE is a fairly unconventional monetary policy but it is used by almost all central banks in one way or another and essentially means an increase in the supply of “money”. As we know from earlier in this blog post, if supply increases then price decreases.
You can apply these basic principles to other finical markets like the price of a barrel of US Oil or the price of an ounce of Gold. If the output of the countries that produces these commodities increases then price will decrease because supply has increased. Alternatively, if there is a drop in the demand for expensive jewellery and watches then price of Gold will decrease.
Let’s look at the chart for Euro vs Australian Dollar FX Currency pair on the 4hr timeframe. I want to show you what intraday support looks like and how and why I have chose this zone to act as support.
Below is the chart and I have the current market level marked on as a support zone. Remember, in my previous blog post I explain the importance of using support zones instead of pip perfect levels because the chances of seeing perfect reactions to single pip levels in the markets are very unlikely.
In terms of market structure, EURAUD has been forming a descending wedge pattern over the past few weeks so that is one of the reasons why it was on my watchlist. These patterns tend to produce fantastic trading opportunities when price finally breaks out of the pattern but I wanted to get in ahead of the breakout to further increase my Reward:Risk ratio of any long positions on this FX pair.
I have marked the chart below with the wedge pattern lines and the difference between the two position entries. You can see how beneficial it is to be able to get in early and trade alongside the mass market demand that sits at the 1.57 zone.
In regards to risk management and profit targets I am a fairly conservative trader. I have my stop loss order placed 25 pips below the lows test of this price zone and my initial target is set at the highs of the wedge pattern.
You can apply these techniques to any timeframe but obviously the ratios of reward vs risk will vary depending on how aggressive you are looking to trade. For example, you will tend to notice a lot more potential support and resistance zones on the 15 minute timeframe and a lot less on the daily and weekly charts. That being said, the basic theories of buyers increasing demand and supply exceeding demand will still apply.
I will show you can example of these principles coming in to play on the Gold spot price chart on the daily timeframe this time. It is very simple to spot these levels and trade them but you do need to practice the techniques and learn the markets you intend to trade so you spot the best demand zones and support & resistance levels.
Multiple wick rejections of the $1280 per ounce price zone. This shows lots of buyers with a willingness and ability to purchase Gold at this price and therefore demand increases pushing price up with it.
However, these types of trades do not always work. Support zones can and do often fail with demand running out. Below is the GBPUSD FX currency chart with an almost identical set up to the EURAUD trade example I showed you previously. Price is forming a descending wedge pattern and has bounced multiple times off of the key psychotically support zone at 1.30. Therefore it is safe to assume that on the next bounce off 1.30 a long position has a good chance of riding increase demand up to new highs and a breakout of the pattern trendline.
As you can see, on this occasion price did not bounce and demand from buyers at 1.30 was exhausted. Before the eventual failure and break of support you can see there were multiple opportunities to buy at this zone with success and that is the key to being a profitable trader in the long term. Building up long term consistent profits by combining a good win rate with trades that have a Reward:Risk ratio greater than 1:1.
Please make sure to like and follow this blog post to stay up to date with my latest and greatest articles! Have a good week.