Where do the trends come from? Or why the price moves - an inside look
"If the market moves in some direction,
then the probability of the continuation of the trend is always higher than the reversal "
Hello. Surely you have repeatedly wondered: “Why are prices moving on the chart?” After all, there is a seller, there is a buyer, they made a deal - everyone is happy. Why would the price rise or fall? After all, if you buy bread in a store, this does not make the price of bread rise. What is the secret here? Or is it part of a global conspiracy? What do brokers hide from us?
No doubt you heard the good old proverb, “Trend is your friend.” Have you ever wondered why Forex trend following strategies work, and why trading in the direction of a trend is such a universally accepted and accepted method?
The reason is simple. The trend is likely to continue rather than stop. After the movement has begun, it is easier for him to continue his existing direction than to stop or, especially, to turn around. This is one of the axioms of trading.
We give this phenomenon various definitions, for example, momentum. What is its real reason? What is really happening on the market, and what really moves the price in the direction of the trend?
So why are prices moving?
To answer this question, we must first consider what drives prices in the first place. As soon as we understand what quotes are driving, we can immediately understand why the trend is developing.
The Forex market is a typical auction market. Think of a regular auction where you, for example, are trying to buy a painting. Initially, a low price is set, then it gradually rises higher and higher, as people make higher and higher rates. The prices you see are the prices at which someone is “ready” to buy or sell, and these prices change without a transaction or any purchase and sale.
The prices that we see on our charts are supply and demand applications. These prices are liquid and they are offered by market makers.
Thus, in order to change the price, it is necessary that there is a corresponding change in these bids of supply and demand. And this can happen in two ways.
First of all, a bank - a liquidity provider - can simply change its applications. Imagine, they initially say that they are ready to sell us an asset at a price of 1.32400 (offer), and then after 30 seconds they change their mind and say that they are actually ready to sell it to us at a price of 1.32450. In this case, the price only jumped 5 points. At the same time, no transaction was made, no one bought or sold anything. Just a market maker changed the price of his offer.
The second way that determines price movement is when someone absorbs market liquidity. On our charts we see only the best Bid and Ask prices on the market, but in fact there is a large pile of other demand and supply bids on either side of the market price for certain amounts at which other banks and market participants are ready to buy from us or sell us this asset.
If we assume that there is a better offer at a price of 1.33373 for the total amount of an asset of 1,000,000 USD, then if a trader comes and buys an asset of 1,000,000 USD at that price, he consumes all available liquidity at a given price, and this offer will be deleted. In this case, the next best offer on the market will be standing above it at a price of 1.33377. Thus, in this example, the price jumps by 0.4 points.
So in this second option price movement is due to the consumption of liquidity through demand for it from the buyer.
Now that we know how prices are changing, we can try to understand why the trend is developing.
So where do the trends come from?
Let's say that you and I are both speculators, and I want to buy 100,000 USD, or 1 lot, of the EURUSD currency pair, and you want to sell 100,000 USD, or 1 lot, of the same currency pair.
My buy order consumes liquidity in the bid price, and your sell order consumes liquidity in the bid price (Bids). In this situation, if market liquidity were equivalent on both sides, we would have triggered an expansion of the spread. But, in which direction the price really completes its movement, depends on the difference in liquidity volumes on both sides.
Suppose that one bank offers at the best BID price an asset of $ 500,000 on your side of the market (sellers), and another bank offers an asset of $ 500,000 on a lower level, and so on down. On the supply side (on the buyer's side), the bank only offers to sell the volume of the asset at 10,000 USD at the best offer price, and the other bank offers the volume of the asset at 10,000 USD at the price above this level, and so on.
Imagine that both of us came with our market orders. You sell 100 000 USD, and I buy the same amount, 100 000 USD. Your sale is carried out at bank rates. But the bid is for 500,000 USD and your order was only for 100,000 USD, so your application was accepted and consumed only 1/5 of the total amount available. At the same time, another 400,000 USD remained available at this level, and thus the price did not actually move. Thus, the high liquidity level on the downside prevents price changes even after the sale.
However, my buy order would be 10 times the liquidity on the offer. That is, if I put up for purchase 100,000 USD, I would buy 10,000 USD at the suggestion of the first bank, and then another 10,000 USD at the suggestion of another bank standing above it, and then the next 10,000 USD at the suggestion even higher. and so on. My transaction of exactly the same size as yours would cause the price to move up 10 levels, due to the lack of sufficient liquidity to execute it at the same price. My order would consume all the liquidity that was offered at the first level and at each higher level. Thus, here is an example of two trading orders of equal sizes in both directions: in one of them the price did not move at all after the execution of your order due to the large amount of liquidity on your side, and in the other the price moved 10 price levels after the execution of your order due to poor liquidity at the top.
Therefore, this will determine the movement of prices. When two equal market orders of equal size are executed, the price will move in the direction of the smallest liquidity.
This is how the trend develops. The broker's profit lies in the spread, so in order to get their profit, they must quickly buy and sell before price changes occur. The broker buys from you and immediately sells the same amount to me, earning a difference for himself. All the dealer needs to do is buy and sell almost simultaneously to make a profit, which is called the spread. If they fail to do this fast enough, they can make unprofitable transactions, and, ultimately, suffer losses.
As the price starts to move up, as in the example above, where dealers sell with me, at a time when there is limited liquidity on one side of the market, the dealer who traded with me is now losing. If another trader came and also made a purchase from the same dealer, their loss may become greater because they are again forced to sell in a fast-moving growing market, and may again suffer losses.
They are trying to reduce further risk by reducing the amount of the asset that they offer to sell to someone else after me. They sold me, and in order to balance their bid books, they need to buy the same amount of asset from someone else at a better price. They, of course, do not want to continue selling in the growing market, because this will lead to an increase in their losses. Their efforts are now aimed at buying in order to cancel their operation with me. Thus, in order to limit the amount that they may have to sell to someone else, they reduce the volume of their offers. This, in turn, further reduces liquidity on the side of buyers, and therefore prices are even more likely to continue their upward movement when any other traders enter the market with an attempt to buy.
That's why "Trend is your friend."
It is a powerful ongoing force that nourishes itself and is gaining momentum more and more. This is what causes momentum. That is why intraday trends are occurring. This is the unspoken mechanics of the trend.
This is an imbalance between supply and demand. Both demand and supply have nothing to do with buying and selling, as most amateurs think. An uptrend does not have to take place, because along with people trying to buy, there are people trying to sell (nevertheless, of course, it can happen).
The number of traders between buying and selling in the same way can be perfectly balanced, as in the example above, when you and I traded the same volume. The trend is because there is less liquidity on the selling side of the market compared to the demand for the asset present in the market.
Thus, there can be an equal number of buyers and sellers on both sides of the market, people like you and me, however, the demand coming from me, from the buyer, is greater than the liquidity reserves currently available on my side of the market, while the demand on your side is less than the present supply. This causes a tendency for the price to move in the direction of my demand, and as soon as it occurs, the price will continue to go further and further in the same direction.
This explains the technical side of the trend and explains the origin of trends and the continuation of their movement.