The Importance of Market Structure in Trading

03.05.2023

Financial market traders analyze markets to find profitable trading setups and identify potential entries and exits. The way a market sets up determines how traders trade, because traders must wait for the market to "come to them."

what is market structure in trading

The way a market sets up at any given time is called the market structure; it is the simplest price action or movement, including the basic resistance and support levels, swings, and direction.

In this article, you'll find answers to the question: what is market structure in trading, how to identify various market setups, and strategies to trade them.

Types of Market Structures

There are three types of market structures; bullish, bearish, and sideways. This section explores how they occur using chart examples, and how to identify and profitably trade these structures. 

Bullish Market Structure

A bullish market structure or bullish trend occurs when the market sets up in an upward trend, having higher highs (HH) and higher lows (HL). Successive price levels are higher and the resistance and support lines often upwards along the trend.

A bullish market trend will go in the upward direction until the price hits a lower low and fails to hit new higher highs.

A bullish market structure looks like this:

Bullish Market Structure

The main way to identify a bullish market structure is to draw trend lines touching a minimum of three of the higher high price points. This trend line also serves as a dynamic resistance line, which traders can use as a market structure trading strategy for the bullish market.

Another strategy for bullish markets is buying drops; here traders find opportunities to re-enter positions when price dips before increasing.

Bearish Market Structure

A bearish market structure forms up when successive prices show lower highs (LH) and lower lows (LL). The price action of a bearish market shows falling prices in a trend that will continue until market forces act to reverse price and print higher lows or even equal lows.

The easiest way to identify a bearish trend is to draw a trend line connecting the highest points of lower highs (at least 3), to get the direction. This line helps traders determine their entry and exit points and also identify the market structure at a glance. When price breaks the trend, a continuation may continue in that direction.

A bearish market structure looks like this:

Bearish Market Structure

Trading with dynamix support trendlines is an effective strategy for bear market structures. Traders may also wait for a temporary increase before re-entering a short sell.

Sideways Market Structure

Financial markets do not always move in an upward or downward direction; they sometimes move sideways, having equal highs (EH) and equal lows (EL). Successive price points do not differ, and the price ranges between each level.

A straight support and resistance line is the simplest way to identify a sideways market structure trading setup. This structure is also called a ranging market.

Here’s how it looks:

Sideways Market Structure

The easiest strategy for trading range markets is to trade between the support and resistance levels, entering when price hits the S or R line, and exiting before it hits the opposite end. The low volatility of sideways market structure may be a concern for traders, given that there's no clear direction.

Traders often use various indicators to find profitable entries and exits when trading these market structures. Some of these are discussed next.

Market Structure Indicators

Indicators are mathematical tools that analyze various market characteristics and display the result as graphical patterns that traders read. There are different categories of indicators, based on the market characteristics. Some popular indicators are the Relative Strength Index (RSI) Bollinger Bands, Moving Average Convergence Divergence (MACD), Fibonacci levels, Moving Averages (MA), and Stochastic Oscillator.

Most indicators fall under these categories:

  • Volume: volume indicates the strength of a market; increasing volume indicates increasing market activity, and is typically considered healthy. Traders use volume indicators to confirm bullish market structures
  • Price Action: price action forms based on price history and may form chart patterns that indicate the direction of a market e.g. higher highs and higher lows show a bullish market.
  • Time: timeframes are important in technical analysis; traders typically begin from higher time frames e.g monthly or weekly and work down to 15 minutes or less. Timeframes are crucial to determine the overall market structure on higher TFs and the structures on lower TFs which may be different.
  • Order Flow: The order flow helps traders choose the right market structure trading strategy by showing the amount of orders to be executed at a price level.

Traders often combine two or more of these indicators to confirm their market structure analysis before taking trades.

Using Market Structure Indicators in Trading

Market structure indicators are useful for identifying potential trading entries, depending on the strategy and the market setups. For example:

  • Trend trading: Market structure indicators like moving averages, support and resistance levels, and trendlines are useful in identifying trends in a market and spotting potential entry and exit points along the trend.
  • Breakout trading: traders use this strategy by entering trades when price breaks above or below a resistance or support level. Bollinger bands are an excellent example of market structure indicators used in breakout trading.
  • Range trading; popular indicators for range trading are horizontal support and resistance levels and Average True Range (ATR). Range traders use indicators to find entries at the bottom or top of a range.

What is a market structure in trading if the trader uses only one indicator? It is often best to combine two or three indicators to confirm the direction of a market structure. Some indicators are limited, lag, and may not account for unforeseen events.

Using market structure indicators helps traders to identify the direction and momentum of a market, and to find suitable price levels to enter and exit trades.

Market Structure Strategies

The three market structures give rise to three different strategies; trend-following, countertrend, and range-bound trading.

  • Trend-following: This strategy is based on the idea that price moves in one direction for a period and traders can profit by following that direction. This allows traders to find entry opportunities to buy or sell assets in the trend. Trend-following trading is more effective in markets with strong trends, both for bullish and bearish market structures.
  • Countrend: This is another market structure trading strategy that works on the idea of price reversal. The idea is that price tends to reverse when it hits a top or bottom level, called overbought or oversold. Traders buy or sell in the opposite direction of the trend when price hits such regions.
  • Range-bound trading: Range-bound traders look for opportunities to enter ranging markets in which price moves within support and resistance levels. Traders buy at support levels and sell at resistance levels, and exit the trade when it hits the opposite level.

Trend-following strategy fits bearish and bullish market structures because they show clear directions. Counter trend also works well in bearish and bullish market structures, while range-bound trading is more suited to markets with sideways market structure.

Trading Psychology and Market Structure

Trading psychology is an important aspect of trading skills that traders learn and continue honing with each trade. Both trading psychology and market structure are crucial factors to the success of any trader’s performance.

Trading strategy refers to the emotional and mental state and management of traders when they trade. Traders experience a range of emotions, ranging from fear to greed, but discipline, patience, and confidence provide the right foundation for traders to make the right decisions most times.

The market structure a trader sees impacts the trader’s psychology to buy, sell, or wait for another opportunity. Disciplined traders may await further confirmations before entering a trader setup. Traders with poor emotional management may jump on trading setups they missed and find their trades entering a reversal.

It is crucial that traders develop a working trading plan to manage their emotions when trading. For example, setting rules to not FOMO (fear of missing out) on missed setups, developing strategies to deal with anxiety and build confidence for market structure in trading. Lastly, understanding market structure helps traders to identify trading opportunities so they can use the right strategies.

Putting Market Structure to Work: A Recap of the Benefits

market structure trading

Market structure refers to the way the price action of an asset sets up, showing the support and resistance levels, swings, and direction of a trend. Market structure shows traders the way price moves, so they can analyze previous data and predict future movements.

Choosing the right market structure trading strategy involves technical analysis and indicators that measure certain market characteristics. Traders can use the structure of any market to improve their trading performance by identifying key support and resistance levels, ranging markets, and trends. That makes it easy to pick entry and exit points to secure profits. Confirmations are important to prevent undue trading risks.

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FAQ

Market structure is the way a market sets up in its simplest form, showing the trend, support and resistance levels, and swings. Market structure shows price action patterns for previous price movements.
Traders identify market structures using trend lines to locate higher highs and higher lows, lower highs and lower lows, and equal highs and equal lows. Trendlines are effective for such analysis.
A bearish market structure, for example, has successive price points showing lower highs and lower lows, indicating that the market is moving downwards for the period.
The forex market has three types of market structures; bullish (uptrend), bearish (downtrend) and sideways (range-bound). These structures have distinguishing features shown by their price movements.
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