Understanding How Large Groups Of Retail Traders Trade

In today’s article, I’m going to be giving you a small lesson in understanding how the majority of retail traders trade the forex market. The reason I want show you how they trade, is because in one of my new articles I’ve got coming out in a few weeks, I’m going to be showing you how to determine the strength of a supply or demand zone. The problem is in order to actually determine the strength of the zone, you must have an idea of how many buy or sell orders were coming into the market before the zone formed. The only way to find this out is to understand how large groups of retail traders trade, as it’s their orders that will make up the majority of the orders entering the market before the supply or demand zone forms.

 

The One Trading Concept Every Trader Uses In Their Trading

Figuring out how large groups of retail traders trade is simple, all we need to do is find the ‘one thing’ which the largest number of traders will use in their analysis of the market.

That ‘one thing’ is of course the concept of the trend.

How many times have you been told that you always need to trade in the direction of the trend ?

The concept of trend is one deeply rooted inside the mind of most forex traders, virtually all traders will incorporate the concept of trend into their analysis of the market in some way. For many traders, the trend forms their fundamental outlook of the market, by that I mean it’s the key thing they’ll look at when deciding whether they should be going long or going short.

The whole concept of trend is based on the idea that the longer the duration of time the market spends moving in one direction, the higher the probability it has of continuing to move in the same direction in the future. For example, if the price of EUR/USD had been falling for two years the people who follow the trend would believe it has a higher chance of continuing to fall than if it had only been falling for one year. Because they believe it has a higher chance of continuing to fall, it means they are more likely to place sell trades into the market after it’s fallen for two years, than if it had fallen for one, because of the fact they’re more certain the market is going to continue dropping.

All traders that implement the concept of trend into their trading believe in what I’ve explained above.

The length of time the market spends moving in one direction is tied to the number of traders who will be placing trades in the same direction. The longer the market falls the higher the number of traders selling, the longer it rises the more who are going to be buying.

image of eur/usd downtrendTake a look at the EUR/USD downtrend in the image above.

You can see I’ve marked two downswings which took place during this downtrend, one with a blue box and one with an orange box. I know from looking at this image there were more people placing sell trades during the swing down marked in blue than there were during the swing down marked in orange.

The reason why is because of how the long the market had been in a downtrend for by the time the swing marked in blue took place. Overall when the blue drop occurred, the market had been falling for 208 days, before the drop marked in orange started the market had only fallen for 39 days. Because all the traders who believe in the concept of the trend believe the longer the market has been in a trend the higher the probability the trend has of continuing, it means more traders will have been placing sell trades when the swing down marked in blue took place than when the swing marked in orange occurred, due to the fact they were more certain the market was going to continue falling by the time the downswing in blue formed.

 

All Movements Are Trends

Now the next concept I need you to understand (which you might already be familiar with if you’ve read my Zero Sum Fun book ) is…..“All movements in the market are trends only not all traders at the same time”

image of downswing on 1 hour chart of aud/usd Here’s an image of a swing down which took place on the 1 hour chart of AUD/USD.

Although to most people this simply just looks like a normal swing down, it is in fact a downtrend, only not to the traders using the 1 hour chart and the time-frames above, but to the traders operating on the lower time-frames like the 5 minute and 15 minute charts. To them this swing down is a fully fledged downtrend due to the fact their time horizons for events in the market are different to the traders on the other time-frames. A few days worth of price action to a trader on the 1 hour chart is not considered to be a long time, but a few days to a trader on the 5 minute chart is like an eternity, so even though the swing down above takes place for the same amount of time on every time-frame in the market, it’s viewed differently depending on which time-frame you chose to look at it on.

image of downswing on 5 minute chart Here’s the same swing down only now we’re looking at it on the 5 minute chart instead of the 1 hour chart.

What’s obvious from this image is just how long it looks like the market has been moving down on the 5 minute chart. Despite the fact the market has been falling for the same length of time on both images, it looks like it’s been falling for a lot longer on the 5 minute chart because of the amount of candlesticks there are showing the price movement. I can’t even zoom out enough to fit in both of the blue vertical lines I used to mark the swing down on the previous image!.

To the traders who use the 5 minute and 1 minute charts this swing down is considered to be a downtrend, which means the longer the market falls, the higher the number of 5 minute and 1 minute traders there are going to be placing sell trades, plus the higher the number of traders on the higher time-frames there are going to be placing sell trades, because if the move down continues it will cause the swing to grow bigger, which will make the traders on the time-frames above believe that a downtrend is taking place on their time-frame.

The reason I’ve shown you these images, is so you can see how even movements which you would never consider to be trends on the time-frame you use for trading, are actually trends to the traders operating on the time frames below. When you look on your charts and see retracements and other swings forming, understand that these are trends to the traders on the time-frames below even if they barely look like trends to you on your time-frame. Because they are technically trends, it means we can find out how many people were going long or short when the swing came to an end just by looking at how long the swing lasted, and then comparing that to the length of the time other recent swings have lasted.

The swing which took place for the longest length of time, is the one which had the highest number of traders going long or short at the point where it came to an end, based on the fact we know the swing is technically a trend to the traders on the lower time-frames.

 

Comparing The Swings

What I want to show you now, is how to compare different swings that formed in the market against one another, to determine which of the swings had the most buy/sell orders coming into the market at the point where it came to an end.

image of three retracements that formed during downswingIn the image above you can see I’ve marked a downswing which took place on the daily chart of AUD/USD with two vertical red lines. Within this daily downswing there were three upswings that occurred as the bank traders took profits off their sell trades and caused the market to retrace back into the downswing.

Out of these three up-swings swing 3 and 2 took place for the same length of time (55 hours) and swing 1 took place for 9 hours. Because swings 1 and 2 took place for a longer amount of time, it means there were more people placing buy trades into the market at the point where they came to an end than there were placing buy trades at the point where swing 1 came to an end. Now even though swings 2 and 3 took place for the same duration of time, swing 2 is actually considered to be stronger than swing 3 due to the fact it caused a bigger price change to take place in the market.

When you have two swings which occurred for the same length of time, the one which caused the biggest price change is always classed as being the strongest, because the size of the price change caused also increases the number of traders who would’ve been entering long or short trades at the time the swing came to an end.

When determining which supply and demand zones are stronger than others, you’ll often not only have to compare retracements against one another, but also consolidations. The great thing is the way we compare consolidations to one another is the same as the way we compare retracements to each other, i.e we look at the length of time the consolidation took place and whichever one occurred for the longest is the one considered to be the strongest.

The main problem is knowing the points where some consolidations begin and end can be quite difficult.image of two consolidations that formed on the 1 hour chart of aud/usd In the image above you can see I’ve marked two consolidations that formed during a swing down on EUR/USD. The points where these consolidations begin have been marked with arrows and the points where they end have been marked with X’s. You can see how it’s pretty clear where each one of consolidations begins and ends, most consolidations that form in the market are like this, but there are some where it’s not so obvious and you have to understand how to determine the point where a consolidation begins and ends in order to figure out how long it lasted.

image of consolidation that formed on 1 hour chart of eur/usd Now it’s a bit more difficult to determine where the two consolidations in the image above begin and end because they don’t begin immediately after the market makes a new low.

In situations like this, what you need to do is find the source of the first upswing that took place during the consolidation (if the consolidation formed during a downswing like the two seen above) and use the candle that made the low of this upswing as the candle you’re going to use to begin your measurement of how long the consolidation lasted. I’ve marked this candle with an arrow in the image above. Once you’ve figured out where the consolidation begins, the next thing to do is find the point where it came to an end.

The candles I’ve marked with X’s show the points where each consolidation came to an end. The reason they’ve come to an end here is because they’ve broken and closed through the low of the first upswing which took place during the consolidation. Once you know the point where the consolidation started and ended the last task is to find out which one lasted the longest.

In the image above consolidation 2 was the most important/relevant in the market due to the fact it lasted for 60 hours whereas consolidation 1 only last for 46 hours. If you drew a supply zone from each of these consolidations, the zone drawn from consolidation 2 would be considered to be the stronger of the two zones, as the size of the sell trades the bank traders got placed to cause the zone to form would have been bigger due to the length of time the consolidation took place beforehand.

The longer a consolidation is, the higher the number of trades the bank traders have got placed into the market, which means the stronger the supply zone drawn from the consolidation is, as the banks won’t want the price to move a large distance past the point where they’ve got a large number of their trades placed if they want the market to continue moving in the same direction.

image of consolidation that formed during usd/jpy upswing Here’s an example of a consolidation that formed during an upswing.

To find the point where this consolidation started from, you need to look for source of the first downswing which took place in the consolidation and then find the candle that made the high of this downswing. I’ve marked this candle with a down arrow in the image above. Once you’ve found this candle you then to find the candle which closed a large distance past the high of this first swing down, as this is the candle which caused the consolidation to come to an end.

After you’ve found where the consolidation started and ended, all you need to do now is measure how long it lasted and then compare that with any other consolidations that formed during the upswing.

 

Summary

I’m sorry if some of the things I’ve talked about in this article have been a little bit confusing to understand, they’ll become more clear when my “How To Determine The Strength Of A Supply Or Demand Zone” article is completed in a couple of weeks. The method I’ve outlined above of measuring consolidations is not something you’ll have to do regularly, so don’t worry if you didn’t quite get it, because most of the time you’ll be able to tell which consolidations lasted longer than others just by looking at the chart.

Thanks for reading, please leave any questions in the comments section below.

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