Most traders do not understand why the markets respond in the manner in which they do. Coming to the market and getting into a trade without really understanding what drives and governs price action, many of them end up on the wrong side of a trade. Market moves look rather unpredictable, and thus investors are confused over buying and selling at the right time.
The concept of imbalances in the market clearly explains price movement. A difference between buyers and sellers drives market fluctuations. Knowledge of these imbalances and how they dictate price action can give traders an enormous advantage. Price action, or the movement of a security’s price through time, contains vital clues about whether a market is in balance, shifting from buyers to sellers, or vice versa.
Learning market imbalances and their connection with price action provides a trader with a decisive decision of when to buy and sell. In the next 3-minute crash course, we’ll break down the full picture of how these imbalances occur and give you a practical primer on using price action to leverage the market.
What Are Market Imbalances?
An imbalance in the market occurs when there are more buyers or sellers of a particular asset. Consequently, an imbalance causes a change in price. That is, if there are more buyers in quantity than sellers, then the price increases due to excess demand relative to supply. Conversely, if there are more sellers than buyers, then the price decreases because of excess supply relative to demand.
Price action, therefore, reflects the level of the balance (or imbalance) between buyers and sellers in that it presents, most often, a clear manifestation of the level of the imbalance. The more extreme the imbalance, the more volatile the movement of the prices. And volatility is the ultimate key to identifying successful market shifts for those traders who can recognize them.
Why Do Market Imbalances Matter?
Understanding imbalances in the market is crucial for any trader since it is what enables you to predict where the prices are headed. Imbalances, in the market, function somewhat like an engine driving and pushing the price movement along. Once you know how to identify such imbalances, you can be in a better position about when to take entry or exit your trades.
Key Takeaways:
- Volatility: Imbalance increases the rate at which price volatility increases. It can be capitalized on.
- Direction of Market Moves: Since an imbalance leads to a possible imbalance in the future also, it is easy to predict whether the market will move up or down.
- Timing Entries and Exits: With the knowledge of imbalances, market traders can make better use of time in making entries and exits, thus generating maximum profits.
How Market Imbalances Create Price Action
It’s pretty plain that the interplay between market imbalances and the kind of price action observed basically is one of cause-and-effect. The imbalance will leave its marks as observable through price action. That is, if buyers outnumber sellers, then we see higher prices and, hence, upward price action. Conversely, when it’s the sellers who outnumber the buyers, the other way around, then prices fall, and we witness downward price action.
A Real-World Example:
The market can be compared to a seesaw. One side is weighed by the buyers, while the other side is weighed by the sellers. When more people jump on the buyer’s side, the market seesaw tips upward, and the prices rise. When more of the people shift over to the sellers’ side, the seesaw tips down, and prices fall. This constant pushing and pulling created by buyers and sellers is the reason for the market’s natural ebb and flow.
Where the Imbalance Actually Happens?
All the imbalance plays out in real-time within price action charts. Your candlestick patterns, trend lines, as well as all other volume indicators will tell you who is turning. Here are tools that will help you find the imbalances:
- Candlestick Patterns: Some candle patterns, for example, engulfing candles or pin bars, indicate when either the buyers or sellers change the momentum.
- Volume Analysis: Correlation between trading volume and price action would indicate if selling or buying pressure is increasing or decreasing.
The points where the buying or selling pressure shifted are where price was faced with support and resistance. In such scenarios, price reacts to key levels, providing clues as to its future movements.
How To Identify Imbalances:
- Look for Breakouts: Breakouts above the resistance level or below the support can be very often indicative of high imbalances, allowing a sharp price movement.
- Monitoring Volume: Big spikes in volume tend to be signs of market imbalances, and major indication that control is about to flip.
- Candlestick Analysis: Once you spot a candle whose close is much higher or lower than the open, you will know that you have big momentum of either buyer or seller.
Monetizing Market Imbalances
Once you see a market imbalance, the idea is to exploit it. The beauty of trading is that you can earn regardless of whether the market goes up or down-if you catch the side with an imbalance.
- Buying: Buy Low, Sell High (or Vice Versa)
The time to buy is when you have an imbalance on the side of the buyers. You will enjoy the price rise because demand is still surpassing supply. - Sell: If the imbalance is moving towards sellers, then it’s time to sell because you will benefit from the downtrend.
By understanding imbalances, leading yourself with price action, you can quickly and accurately make decisions that you don’t have to predict every single move, but being aware of an imbalance could place you before others do.
Common Trader Error Regarding Market Imbalances
The experienced traders can sometimes commit the same mistake by getting early trades or holding for too long. The most common mistake is actually caused by impatience, as trading market imbalances require waiting for confirmation.
Avoid these pits:
- Trade without Confirmation: Never trade into an imbalance unless it’s obvious and price confirms the shift.
- Ignoring Volume: Price action alone does not tell the full story. Volume is very important in confirming if the imbalance that indicates a move in the market is strong or just a feature of speculation.
- Failure to Set Stop-Losses: You can be right, and yet still find yourself on the wrong side of an imbalance as changing market conditions could occur rapidly. Always protect your capital with stop-loss orders.
Conclusion
To master trading, one needs to be aware of imbalances within the market. These imbalances in the number of buyers and sellers are what move and pull the prices to create opportunities for trading. Learn how to catch these imbalances against the wall and act in time so as to make better trading decisions and thus raise your probability of profitability.
Be it an intermediate or a novice trader, shifts and the subsequent price action due to imbalances will put him on the right side of the market. Remember, key observation alone is not sufficient but use their movements to your advantage by proper timing entries and exits.
This knowledge applied will let you capitalize on market moves and take your trading to next levels.
