All language subtitles for 1. Market Mechanics

so now we should have a very solid understanding of market structure and

how we essentially use market structure as a mechanical framework to guide us

through the order flow of the market but now we are ready to start to look at

the actual mechanics of the market as in what is actually behind the production

and the interaction of that order flow that then generates the market structure

that we have just been spending time analyzing

now as history has repeatedly shown speculators as an aggregate they are

often a very very emotionally charged group and when you get millions of them

together in a highly emotional money game of fear greed and uncertainty their

combined behavior kind of takes on a kind of you know herd mentality

so technical analysis is the framework that we use to identify training

opportunities through the study of price movement and volume

from that battle between buyers and sellers that is then reflected on a

price chart so big commercial companies you know

putting huge orders through the market to save a japanese construction company

maybe they need to buy thousands of tons of timber from canada for example

then they're going to need to exchange a large amount of japanese yen for

canadian dollars in order to make that purchase

so they approach the dating desks at large banks to facilitate that

transaction on their behalf so bfis banks and financial institutions those

are the other big players who are putting you know massive orders through

the market for various reasons then we also have speculators who are

purely trading to try and extract the profit from the movement in exchange

rates right and this also includes large finance institutions as well as

independent retail traders such as us now that is of course not an exhaustive

list of market participants it's just kind of some of the main ones that we

can think about now all of those are affected by the

forces of human emotion that come into play when sums of money are involved

and all of this behavior and participation is what drives the order

flow that is put through the market so that interaction of buyers and

sellers with that order flow then prints the price action that we actually see on

our charts and that price action then creates

patterns and it's these patterns that repeat

themselves over and over time and time again

you know crowd psychology has been reflected in the prices of stocks

indices commodities futures and currencies since the beginning of the

free market and that interaction of you know

millions of different participants for as many reasons all of their own

emotions and agendas that forms price patterns that stretch over extended

periods of time and can be used to make high probability forecasts of where

price may potentially move in the future now currency exchange rates they move up

and down as a result of supply and demand from market speculators

so every day investors and traders both institutional and private individuals

all buy and sell currencies and the numerous types of market participants

that we just discussed they are buying or selling for their own unique reasons

with their own unique views ideas and beliefs around what the currency pairs

they are trading are actually worth now the meeting point of those buyers

and sellers for whatever reason that they are acting is price

so no trades can take place unless both the buyer and the seller actually agree

on a price so this drives the price of currency

pairs with buyers bringing with them demand for the pair applying that up

with pressure on prices while sellers bring supply applying downward pressure

on prices and the market runs like a continuous auction throughout the day

with buyers and sellers constantly competing with each other to get the

best possible price now in a perfect kind of free market

this would be a pretty smooth and fair process however in the financial markets

this can often be quite a heavily manipulated process

so let me explain first we need to have a quick and very

very basic lesson on economics 101. so on this diagram on the y-axis on the

left-hand side we have the price level for the cost of product x right and then

down along the bottom on the x-axis we have the quantity of product x that is

available to buy from sellers of product x

so now what we do is we plot on this line here and this line represents the

the demand from people for the product

so obviously at the start of the curve where price is at its highest the amount

of quantity demanded for product x will be near its lowest because not everyone

really wants to pay or maybe can afford such an expensive price for product x

but as the price falls the demand for it will increase and increase and increase

more people will want to buy or will be able to buy the product as it gets

cheaper that makes logical sense right

of course there are some exceptions you know like designer clothes for example

where more people actually desire them the more expensive that they are

but generally when something is cheaper more people want and demand it

so at the lower price p2 more quantity of the product is demanded

at q2 so demand increases

as the price falls now let's just remove the demand curve

for a second and we'll bring it back in a minute

so this line here represents the supply of product x

so down at the start of the curve on the bottom left-hand corner where price is

at its lowest the amount of quantity that is supplied to the market for it

will be at its lowest but as the price rises the supply of the

product will increase and increase and increase

because suppliers so sellers of the product they will then be more heavily

incentivized to supply and sell the product because they're going to receive

more money right in exchange for actually supplying it

so hopefully this also makes logical sense because the higher the price that

you can get for selling something generally the more of it you're going to

want to sell or you know more people will then enter

into the market and they will also start to sell it

so the total supply of product x will increase that the higher the price is

so supply increases as the price rises but we can't just only have sellers in

the market and we can't just only have buyers in the market we need both a

buyer who demands a product and a seller who supplies the product

because it takes two to make a market so when you plot both the demand curve

and you plot both the supply curve over each other

you can then see where the market price will be

so where buyers and sellers meet is where they agree to exchange money for

their goods or service and that determines the market price

so that price for the supply meets demand that is the fair market value

but what happens if there is a lot of demand for a product

what if there is so much demand that the product completely sells out and there

are no more sellers left at that price level but people are still demanding it

people still want to buy it but there's no one there to sell it to them well the

price is going to increase right because there needs to be an incentive

for new suppliers to enter the market to fulfill that increase in demand

or people you know who still have the product left to sell they're simply just

going to increase their prices because they know that they can get away with

charging a higher price right because there is so much demand that people will

be willing to potentially pay a higher price

so what happens is the demand curve shifts up like this

so now the price goes up in order to increase the supply of the product

to meet that increase in demand for it so if everyone wants to buy a product

but nobody wants to sell it at the price p1 then the only way to either fulfill

or reduce the demand is to increase the price to p2

so then you'll get the increase in the quantity supplied from q1 to q2

so if the price goes up then the amount of supply will go up

and the market reaches a new higher equilibrium price

from that increase in demand and this is the new fair market value

so the exchange rate in the forex market it works by the exact same principle

this mechanism is going on continuously every single second that the market is

open and price is constantly moving pip by pip

to match the price perfectly between the demand and supply

between both buyers and sellers and that is how a free market works

now the more liquid a market is the easier that price can slowly you know

move slowly and smoothly up and down but when there is an overwhelming

imbalance between the supply and demand so when there is a lot more quantity

demanded then there are actually sellers supplying it or maybe a lot more sellers

supplying the product then there are actually people willing to buy it at the

current market price then there is an aggressive change in

the price level because either the supply or the demand

right it has to shift a significant amount to find the new market

equilibrium price so in an ideal situation if markets are

absolutely perfect this would be quite a natural process where buyers and sellers

can freely agree on price however in the financial markets this movement of price

is often quite a manipulative process so the big players that we mentioned

earlier you know the banks the hedge funds and any any sort of large

institution they have the ability to control

movements of price to a degree due to the huge amounts of volume that they put

out into the market you know using all sorts of tactics to trick traders into

potentially taking the other side of their positions in order to utilize them

for liquidity now being able to recognize this is

going to bring you one step closer to joining them

because what if i told you that on the price charts they actually leave

footprints and clues indicating their manipulative actions

see these institutions they just have no way to actually hide the overwhelming

imbalance in the supply demand that they create

to cause price to move in their favor because their order flow is just so

large because when they put their orders

through it creates those huge shifts and imbalances in the supply and demand in

the market now every time frame shows the same

patterns again and again where you can literally see where this is happening

so using all of the time frames together you know it's going to provide a clear

picture on where the big players are entering and exiting the market so that

we can time our entries and exit with extreme precision using a mechanical

edge but before we look at how we can you

know see these imbalances being caused between supply and demand by those big

players on our price charts first we must understand a little bit

more about the mechanics behind that order flow in the market

so order flow is the interplay between both passive and aggressive orders in

the market in more simple terms it essentially just means the interaction

between buyers and sellers so the supply and demand that they bring into the

market via their orders right that they are

putting through the market now a passive order is an order in which

the price is different from the current market bid and ask price

so this is typically limit and stop orders so orders which are waiting for

price to either come up or come down to them to hit them

so kind of a really simple way to think about this is passive orders are

essentially just pending orders sitting in the order book waiting to be filled

when price eventually reaches them so remember

a limit order is one where you buy or sell at a specified price or better

below or above the current market price now the other type of passive order is

called a stop order and a stop order is where you buy or sell at a specified

price or worse above or below the current market price

now if you haven't done so already please watch the module on brokers where

we discuss the different order types in much more depth

so both of those stop and limit orders are

classified as passive orders so essentially they're just pending orders

that are sitting in the order book waiting to be hit right but the other

type of order is called an aggressive order and aggressive orders are when a

trader executes the order instantly so that they buy or sell at the current

best market ask or bid price so it's generally an at market order

so if you just want to instantly buy an instrument right you will get filled at

the best current ask price and if you instantly want to sell an

instrument then you will get filled at the best current bid price

so order flow as a whole

it is essentially just the interaction so the interplay between all of these

types of orders so you have the passive orders those pending orders that are

just sitting there in the order book waiting to be hit

and then these passive orders are actually visible in the order book you

can see them you know just sitting there but then you have the aggressive orders

where traders just step in and instantly hit either the current best bid or ask

price so what does that actually look like

well something that is commonly used in the markets which trade through a

central exchange such as the futures market and most

stock markets is a price ladder which essentially visualizes the order book so

it's otherwise known as the dom or the depth of market and it shows all of the

bids and offers you know those passive orders that are sitting in the market

those limit and stop orders and it shows the amount of volume so the amount of

supply and demand that is sitting at each individual price level

so on the left hand side you have the bids so the amount of demands that is

willing to buy at each price level and then you have the offers on the

right-hand side so commonly referred to as the ask prices which shows the amount

of supply at each price level so the top green level is the current

best market bid and the bottom red level is the current best market ask

and the blue price in the middle that represents that last price level that

was traded at so in this case the last trade that was executed was someone

buying at the ask price of one spot one five three zero

because remember you have to buy at the ask on the right and you sell on the bid

price on the left so if you want to sell then you have to

sell to the highest bidder and if you want to buy then you can buy from

whoever is asking for the lowest price for the product right

now when you go and look at your own forex broker what you will see is just

the current best bid and the current best ask and then the difference between

those two prices is the spread right so in this case the spread would be 1.1530

minus 1.1529 which essentially means a spread of one pip

so if you wanted to instantly buy an instrument that would be an aggressive

order and you would buy at the current best ask price meaning you would hit

that passive order at 1.1530 and you pay the spread of one pip

so let's take a look at a very very oversimplified uh you know a theoretical

example of what can happen on the order book in the live market

so imagine that this was the order book for euro dollar

now let's say that a company over in america

they want to buy an innovative tech company that is doing really really well

in europe now that american company is going to

need euros in order to buy that european company right so they will call up their

banks dealing desk and they will say that let's say they need to buy 20 000

lots of euro dollar because they're gonna need to sell their

us dollars to buy euros right and they tell the bank standing desk

that they need this transaction completed within 48 hours uh please give

us the best possible price now the banks traders you know sitting

on that dealing desk they may not want to put through all of those 20 000 lots

all in one go because there may not be enough liquidity to fill that huge order

without experiencing massive slippage because if we look at this current

example if you look on the right hand side we

can see the amount of supply that is sitting there on all of those different

ask prices now if the bank was to instantly buy at

market with those 20 000 lots price will absorb all of the supply on

the right-hand side you know that huge demand that the bank would be entering

into the market it's going to eat up all of that supply and price will just keep

going up and up and up until every single one of those 20 000

lots have been filled you know if they were to enter that with

an aggressive order so an app market order

so what they may do instead is split up the order into smaller parts to hedge

the risk of experiencing that negative slippage and see if they can average out

a better price for their client so let's keep it simple and let's just

say that they enter half of the position now so they press buy on 10 000 lots for

an app market execution so they hit the best current ask price

and what will happen is the 10 000 total lots sitting on those ask prices will

instantly get absorbed and the price will shoot straight up to 1.1539

due to that huge imbalance between supply and demand right because there

was an overwhelming amount of demand at that current market level so what did

price have to do price had to rapidly shoot up in order

to fulfill that huge shift in demand until there was enough supply at a

higher price level to balance price back out to you know balance both supply and

demand and now the market is sitting at what is deemed to be fair value between

buyers and sellers so half of their order has now been

filled but the bank doesn't want to you know

keep chasing the market higher and higher and get filled at an even worse

price for their remaining volume right for those remaining 10 000 knots

so what they do is they leave the remaining 10 000 knots as a passive

order so as a buy limit order back down around that original price level of

1.1529 as this is where they hope that the

market will eventually trade back down to fill them uh within the next 48 hours

for their client now if price eventually gets back down

to that level of 1.1529 what do you think are the odds that

there will be more supply than demand to absorb all of that demand of that huge

buy order of 10 000 knots and the rest right to keep pushing price down past

that level to keep pushing price down past 1.1529

i would say the probability is that price is more likely to see a bullish

move from that price level or at the very minimum there will be a bullish

bounce right there'll be a bit of a reaction as the market experiences that

imbalance between supply and demand at that level

so essentially what this does is it gives you a really great edge to look to

be buying around that level right with this huge demand and then surf on the

coattails of that order flow right of the order flow of the whales of those

large institutions in the market now because the spot forex market is an

otc market which means it's traded over the counter this means it is a

decentralized market so there isn't one central exchange where all of the total

volume and all of the total trading activity goes through

so you can't really look at an order book of just one liquidity provider and

get a super accurate view of what the true total order book looks like for the

entire forex market as a whole but we don't need to and also in reality

you know reading a price ladder can be very very complicated as all of this

buying and selling activity so the interaction between supply and demand is

extremely dynamic especially when you throw in the aggressive orders that are

hitting the bids and the asks that are sitting there so it can be very hard to

read so instead what we use is a price chart

and a price chart gives us tons of information on the current and the past

prices that have been traded and in the chronological order in which those

levels were traded so essentially we just see that middle

column here of how price moved up and down those levels but also how quickly

price moves up and down those levels and that's where multi-time frame analysis

comes into play and that's why we use candlestick charts because they give us

a lot of information but you just need to know how to be able to read it

effectively so with this example on this order book

here of what we just went through how could that example possibly look

like on a price chart well how we may potentially see you know

something similar to that and the order book theory that we just looked at

obviously a very sort of you know oversimplified theory of how it really

goes on in the market where we have you know millions of different participants

but generally you'll see price kind of chopping around sort of you know ranging

sideways moving up and down not really going anywhere with real conviction

right just some even distribution between buyers and sellers

and then boom what happens we get that overwhelming imbalance between supply

and demand right where demand has clearly overpowered supply and we have

initiated of that range and broken to the upside right so imagine you know 10

000 the order's just been filled and pressure is priced all the way up to the

upside to try and find as much supply in order to fill all of those those lots

that that um you know the bank firmware institution wants to buy so price then

shoots up to the upside but it's very likely that there's still

going to be a lot of sitting demand back within those initial price levels um of

where there'll be orders and liquidity that price wants to then fill so we will

very often see as then price start to make its way back down towards that

alert of it back down towards that level pick up those orders and then boom

you'll see another imbalance between that supply and demand again as those

remaining orders are filled and demand is now fully in control and yeah we just

see the same thing happen again and again and again right if you just go and

look on any single price chart and you just scroll back right you'll just see

the exact same thing happen again where which you have price ranging price

initiates out as we get that imbalance between supply and demand price comes

back into that demand and it fills the next orders right we get that range

price initiates out the price comes back in to fill those orders right we get a

range pricing initiates outright the origin of that move price comes in to

fill more orders and then we move away right we initiate out that range price

comes back into for those orders with a demand stepped in and we initiate that

range right we come here break up those highs price comes back in

to fill the remaining demand right it just happens again and again and again

right price ranging we initiate out price comes back in to fill those orders

right same thing original range down here right that was the origin of the

move price comes in a little bit lower to fill those orders right it needed

more demand to then continue that move and the same thing will just continue to

happen right just get rid of all that price action and play it forward a bit

um you know it's on every single time frame right

time doesn't know price price is no time it's just orders going through the

market that we can then see on those calendars right as price continues to

move up right it pulls back it ranges demand steps in again to take control

boom right pull back into demand to then continue to fuel the move right then we

have this range here demand steps in price comes back in to fill those

remaining orders and then we come off right demand steps in price comes back

into that demand to then make another move here right again and again and

again so obviously we'll cover this a lot more depth in the charts in a bit

but now you can kind of just see how a simple example like that actually is

translated onto the candles on the charts

so if you're a little bit confused potentially about some of the things

that we just discussed in this lesson you know don't worry too much watch it a

few times if you need to just to kind of you know really make it sink in

but when it comes to supply and demand the following is literally

all you really need to think about so literally all we're doing is we're

just looking for where there are large imbalances between supply and demand

that cause those huge shifts in the market

so we are trying to identify the charts you know where an overwhelming amount of

demand entered the market to cause price to rapidly move to the upside but then

we'll look to buy when price returns to those areas of demand

and then we'll also look for where there was an overwhelming amount of supply

that entered the market to cause prices to rapidly move to the downside and

we'll look to sell when price returns those areas of supply

now when we combine this with everything that we already now know about market

structure so when we've identified the exact high value areas of the trend in

which we want to position ourselves in right we've used multi-timeframe

analysis to wait for all of those time frames to sync to give us as much

confirmation as possible then we over overlay that and overlap

that with supply and demand that then becomes another extremely powerful tool

to help us with timing and refining our positions

and our exits and this is what we're going to dive

really deep into over the next few lessons