Market Structure: Learn How To Trade

We need to holistically look at the market structure and how it goes through different cycles. There are many different methods for this. I’m going to explain the market structure in the way that I’ve learnt and found through experience.

Following on from our lesson on market analysis, we will look more closely at the general market structure.

Broadly speaking, prices can either go up, down or sideways (some would argue that markets are a binary ‘up or down’ but we can accommodate for sideways markets as well). The following is based on my own interpretation of the Wyckoff model.

Market Structure

Markets broadly go through 2 structural phases, as follows:

  • Ranging/Accumulation/Distribution/Consolidation – this is sideways price movement. Prices will stay in roughly the same area for an extended period of time, while the bigger players execute orders while there is price stability.
  • Trending/Uptrend/Downtrend – usually characterised by directional movement either upwards or downwards. Prices can quickly move through areas, highlighting the imbalance between supply and demand.
Wyckoff cycle drawing
Image credit to StockCharts.com

For the purposes of being specific, let’s describe 4 phases:

  • Accumulation – the consolidation before a move up
  • Uptrend – the trend up after accumulation
  • Distribution – the consolidation before a move down
  • Downtrend – the trend down after distribution

Accumulation and Distribution Model

Accumulation

This is the phase which we can think of when we a market is ‘bottoming’. It’s characterised by:

  • A balance of both supply and demand
  • Sideways market movement
  • A market bottom
  • Could result in divergence of traditional indicators
  • No clear pattern in market swings
Chart of WTW showing accumulation
Click to enlarge

This is a market phase which typical retail traders, following the ‘trend is your friend’ mantra, will ignore. However, larger traders use the balanced market to accumulate large positions carefully, without moving the market to disadvantageous prices.

The market’s supply and demand is broadly balanced, shown by the lack of directional price movement.

If a large buyer were to buy in an established uptrend, when there is limited supply in the market, they would push the market even higher. This is not what big traders want. They want to get in at a relatively stable price area, so as to not push prices away from them and reveal their buying.

Accumulation zones often have reasonably clearly defined upper and lower boundaries, shown by horizontal support and resistance. The lower boundary often rejects quickly, showing the lack of selling pressure.

Often there are price patterns within larger accumulation zones, which we can profit from. These are going to be discussed further along in the series.

Accumulation zones eventually end with a breakout, leading to the start of an uptrend, and therefore higher prices.

Uptrend

The name of this market structure is quite self-explanatory. It is a directional move upwards, usually from an area of accumulation, to an area of distribution. It’s characterised by:

  • Prices rising
  • Demand overwhelming Supply
    • Lack of selling pressure
    • Abundance of buying pressure
  • Higher highs
  • Higher lows
  • More participation due to trend traders and breakout traders
Chart of WTW showing accumulation and following uptrend
Click to enlarge

The market structure during an uptrend usually consists of prices broadly following an upwards trajectory. The supply and demand dynamic in this market is such that prices will move up.

This is either due to a lack of supply or excess of demand, causing the market to move to it’s next equilibrium (either further accumulation or a distribution phase).

Distribution

This phase is very similar to accumulation, with almost identical market structure. The main difference is that a distribution phase is a market top, rather than a bottom.

Much like accumulation, prices are moving sideways and the supply and demand in the market is broadly balanced.

Chart of SLA showing distribution
Click to enlarge

This phase is usually where big players will distribute their position back into the market. They look to sell their long position at this stable price area, and perhaps initiate short positions.

Showing the same clearly defined upper and lower boundaries of market structure as the accumulation phases, we often see the upper boundary quickly rejected, highlighting the lack of further demand.

Usually ends with a strong downside breakout, or breakdown.

Downtrend

This phase is the opposite of the previously mentioned uptrend. The market structure is defined by:

  • Prices falling
  • Supply overwhelming Demand
    • Lack of buying pressure
    • Abundance of selling pressure
  • Lower highs
  • Lower lows
  • More participation due to trend traders and breakout traders
Chart showing distribution and following downtrend
Click to enlarge

What The Books Don’t Tell You:

No model is perfect. Markets are random some of the time and will not always behave in this way.

While this model of market structure can work well at times, you may find times when markets do not reflect it in the slightest. We need to take this into account when analysing markets, and not force the model onto our charts. If it isn’t there, that’s fine.

We also need to be aware that an uptrend does not always lead to distribution (nor downtrend to accumulation). Market structure will often look like distribution, but continue higher. This can be thought of as re-accumulation (or re-distribution for the opposite).

Litecoin chart showing accumulation and uptrend, followed by indecision
Click to enlarge

Drawing of the complex market cycle

Back to Trending or Ranging

It’s too simplistic to think that markets will always go between up and down cycles. There are of course other macro factors which can cause multiple accumulation and re-accumulations, without going through a distributive phase and downtrend. (Just look at the market structure of the S&P 500 and EURAUD).

Chart showing numerous market cycles
Click to enlarge
Chart showing numerous market cycles
Click to enlarge

We cannot easily predict whether a range will lead to an up or down trend ahead of time. What we can easily do is define a trend or range environment. The chart above shows numerous phases in all different mixes.

All we can do is try find clues ahead of time as to what direction we expect, and act on these clues.

In the next article we’ll discuss ways to define these elements of market structure and how to identify them. Subscribe down below if you haven’t already!