An easy way to tell if someone is a novice trader is by asking them “why does the price move up and down ? ”
If they reply “because there are more buyers than sellers” or “because there are more sellers than buyers” you know the trader is a beginner and has not learned the information he needs to be able to trade the forex market profitably.
The more buyers/sellers advice is the reason many traders and books give as to why the price of a currency moves up or down. You even see traders who run large forex educational sites state this as being the cause behind price movement yet its complete and utter nonsense as I’ll explain to you throughout this article.
Today I’ll show why the amount of buyer or sellers there are has NO effect on the price movement in the market and how you can make an estimation of how many buy or sell orders are coming into the market based off the previous price action.
What Causes A Price Change ?
Each day we open our charts and see the market price move up and down. Some days it only tends to move up, and some days it will only move down. The more buyers than sellers/more sellers than buyers myth states the reason the market price moves is because there are more traders present in the market placing buy or sell trades than there are of other traders.
Apparently the reason the price moved up from the low marked above was because there were more buyers in the market than there were sellers.
What I don’t understand is why would be people be buying after a large move down ?
Retail traders typically tend to sell after they see a large move down, this is confirmed by watching Oanda’s order-book after a big move takes place, so if the price did indeed move up from here because of there being more buyers than sellers it can’t be the retail traders who are the ones buying.
Therefore it must be the banks, the problem is there are a far fewer amount of traders working on behalf of the banks than there are trading independently i.e retail traders so its highly improbable for there to be more bank traders in the market than retail traders.
So if we know the banks are the ones who were placing buy trades to cause the move up and we also know its very unlikely for there to be more bank traders in the market than retail traders, what was the reason for the price moving up ?
The answer…….
……….Because the buy orders were bigger than the sell orders….
It has nothing to do with there being more buyers than sellers, you could have 10,000 sellers and 10 buyers, if the ten buyers are buying more than what the 10,000 sellers are selling the price will move up.
Lets use our example of the image and say there were 1000 sellers who’s sell orders collectively added up to there being 5000 sell orders coming into the market at the low. All that needs to happen in order for the price to move up is for a buyer to come into the market and place 5001 buy orders. If he does that all the 5000 sell orders will be consumed and the price will move higher, it will keep moving higher until another sell order is found for the remaining buy order to be matched with.
How Many Orders Does It Take To Move The Market
Knowing how many orders it takes to move the market price is impossible because we don’t have access to a proper forex order-book. If we did then we would be able to watch the buy and sell orders come into the market and see for ourselves how many orders are needed to move the market price from one point to another.
Now although we don’t have an order-book, what we can do is use our understanding of the market and how people trade to make an estimation as to how many orders may be needed to cause the price to change direction.
When I say estimation, I don’t mean we can say there are roughly 150,000 sell orders currently coming into the market……
What I mean is we can predict, based on the current price action, if there a small amount of orders coming into the market or a large amount of orders coming into the market.
Different market structure means a different amount of orders based off how people are reacting to the price changes.
For example, we know the longer the market moves in one direction the higher the amount of traders placing trades in the same direction. This means the amount of orders coming into the market will increase the longer the price manages to move in one direction.
By knowing this we can determine that in order for the market to change direction, a large number of opposite orders are going to be needed.
Take a look at the beginning of the AUD/USD downtrend above.
By the time the price has dropped down to where I’ve marked the first arrow on the 10th June there are millions of sell orders coming into the market from retail traders.
At this point most of the traders have seen AUD/USD is in a downtrend and have begun selling under the impression the price is going to continue declining. The two things which cause such a large mass of traders to all start selling is the length of the down-move and the nature in which the price dropped.
If you look on the image at the point where the price first began falling, you’ll see for 7 consecutive days the price fell and there was no sign of any bullish candles, when traders see the market fall for such as long time and such a large distance they assume its going to continue falling forever.
This may sound silly to some people but don’t forget the majority of the traders who trade the forex market are actually stupid in terms of what they do and how they think. It only takes one look at my article on what we can learn retail traders using Oandas order book to see how the majority of traders trade and how the traders who use strategies are actually the minority not the majority.
With each successive drive down more and more traders begin going short, each failure to move higher is a signal to them the price is more likely to continue falling than it is to start rising. By the time we come to the low made on the 24th of July there are tens of millions of sell orders all coming into the market from hundreds of thousands of traders, in order for the price to start moving higher from here a bigger number of buy orders need to be placed than the current amount of sell orders coming into the market.
Where do these buy orders come from ?
Bank traders taking profits off sell positions.
The banks placing sell trades is what caused the downtrend to begin in the first place, as the market falls the profit on their trades grows bigger and bigger, meaning the amount of orders they need to be able to take profits off these sell positions also grows bigger.
So the banks need to have an increasing amount of traders entering trades the further the price moves in one direction to even have the ability to take profits off their own trades.
This why I think the concept of trend and the assumptions it makes about the market are incorrect because it causes traders to enter trades late into the lifespan of a trend and thus their orders end up being used by the banks to take profits off their trades.
Summary
Hopefully with this article I’ve proven to you why the more buyers and sellers theory is wrong and the real reason why the market price fluctuates up and down is because of one set of orders being bigger than the other. Knowing how many orders are coming into the market can only be achieved by understanding what effect the price action has on the traders outlook on the market.
This is the key to understanding why things like reversals – consolidations – retracemetns take place and is essential for you to have a deep knowledge of why the market works.
Thanks for reading, please leave any questions in the comment section below.
Source: http://www.forexmentoronline.com/