Understanding Market Structure

Market structure is the foundation of technical analysis, referring to swing highs, swing lows, supply and demand areas, order flow, and overall market conditions. Market behavior generally falls into two categories: trending and ranging.

The Uptrend

In an uptrend, the market moves upward, creating new higher highs and higher lows. An ideal ascending structure respects the previous lows and continues pushing higher. In this environment, the market has a greater tendency to break previous highs to the upside. As long as the price continues to break these structure levels, the uptrend remains intact.

Break of Structure (BOS)

A breakout occurs when a candlestick clearly breaks the previous market structure with its body. To be considered a valid break of structure, the price should close a visible amount (such as a couple of pips) above or below the previous level.

Validating a Break vs. a Liquidity Grab

It is crucial to distinguish between a true breakout and a fakeout (liquidity sweep). In a liquidity sweep, the price wicks beyond the structure but immediately returns to the previous range. To ensure a break is valid, look for these signs:

• Candle Close: The candle must close outside the range with its body.
• Follow-through: The subsequent candle should close above the previous candle's close, indicating buyers (or sellers) are in control.
• Double Confirmation: Wait for the following candle to violate the highest point of the breakout candle. This indicates strong momentum rather than a temporary grab.

Reversals and Change of Character (CHoCH)

A reversal occurs when a trend shifts direction (e.g., an uptrend turning into a downtrend). This is often identified by a Change of Character (CHoCH), which is the break of a trend's origin point.

The Rule of Scale

Not every break of a small internal level constitutes a reversal. To identify a valid CHoCH, apply the following rules:

• Impulsive Move Size: A valid CHoCH occurs when the price breaks the lowest point of the latest impulsive move, provided that move is at least half the size of the previous impulsive move.
• Comparison: If the previous move was 40 pips, the latest impulse must be at least 20 pips. If the latest move is too small, a break below its low is not considered a valid trend reversal.

Liquidity Concepts

Structure and liquidity are inseparable. Liquidity generally resides above old tops and below old bottoms. In a bullish market, the price often "sweeps" liquidity below recent lows to gather the "fuel" needed for the next move upward.

Identifying Liquidity Sweeps

Candlestick formations are vital for identifying these movements. A long wick at the bottom of a candle (in a bullish scenario) that penetrates a support level and quickly returns is a classic liquidity grab. For a clear signal:

• The wick should be at least half the size of the candle body.
• The candle should not have a corresponding long wick at the opposite end.

Combining Structure and Liquidity for Reversals

When a liquidity sweep occurs at a major structure point, it can signal a possible reversal:

• Temporary Reversal: Grabbing liquidity above a high in an uptrend suggests a temporary drop, but the trend is not officially over.
• Confirmed Reversal: A true reversal is only confirmed when the price breaks and closes below the most recent origin point (the source of the last break of structure).

By combining these concepts—watching for liquidity sweeps to identify momentum loss and waiting for a break of the origin to confirm a change in direction—traders can significantly improve their win rates and risk-to-reward ratios.