Be sure to watch the GBP/JPY live trade video (previous post).
Below is a conversation I had with a friend of mine who is learning to trade. We were discussing what is behind the market economically and how the market sets prices for us to use as reference points so we know where to buy and sell in order to make profit. I thought there were some things in our conversation worth sharing and so I cut and pasted it below.
Take note of these market concepts and realities, because whether you like it or not or whether you choose to believe it or not, if you are trading you are in the middle of these ideas and they are influencing the market that is all around you. Getting these ideas down will help your trading exponentially in my opinion.
Hope this is some help to some of you. Enjoy. 
[1:58:54 AM] Fetor: is the price expensive or cheap?
[1:59:02 AM] Fetor: are people willing to buy more or sell more?
[1:59:06 AM] Fetor: those are the questions
[1:59:19 AM] Karim: idk about expensive and cheap
[1:59:49 AM] Fetor: if the price is too expensive what do people do?
[2:00:00 AM] Karim: sell and run for the hills
[2:00:04 AM] Karim: wait for better price
[2:00:07 AM] Fetor: and if it is cheap?
[2:00:15 AM] Karim: load the boat
[2:00:20 AM] Fetor: correct
[2:00:24 AM] Fetor: fx is no different
[2:00:27 AM] Karim: but
[2:00:36 AM] Karim: what defines expensive and cheap
[2:01:02 AM] Fetor: it is defined by the price that the market is setting
[2:01:11 AM] Fetor: where are your reference points?
[2:01:17 AM] Karim: ok i see
[2:01:28 AM] Fetor: how do you know if something you are buying is a good price?
[2:01:32 AM] Fetor: let’s say a jacket?
[2:01:39 AM] Fetor: or a pair of pants?
[2:01:43 AM] Karim: relitive to other shops
[2:01:43 AM] Fetor: is it a guess?
[2:01:46 AM] Karim: and other products
[2:01:52 AM] Fetor: ok
[2:01:58 AM] Fetor: you use a point of reference
[2:02:02 AM] Karim: ya
[2:02:03 AM] Fetor: the market sets the price for you
[2:02:09 AM] Fetor: and you make your decision based on that
[2:02:14 AM] Fetor: i know I’m simplifying it some
[2:02:21 AM] Fetor: but I’m trying to get you to think a certain way
[2:02:29 AM] Fetor: why would someone sell?
[2:02:33 AM] Fetor: why would someone buy?
[2:02:37 AM] Fetor: those types of questions
[2:02:44 AM] Karim: ok
[2:02:46 AM] Karim: so
[2:02:52 AM] Karim: looking at taht daily chart you sen tme
[2:02:54 AM] Karim: sent me
[2:03:03 AM] Karim: lets say we didnt have the last few sessions
[2:03:13 AM] Karim: and price was comming down to the 6250 lvl
[2:03:31 AM] Karim: would you consider that cheap
[2:03:32 AM] Karim: ?
[2:03:44 AM] Karim: since hte market set a refrence there
[2:05:01 AM] Fetor: well….at that point though you are adding on to what you know about trending pressure and the probability of buying
[2:05:44 AM] Fetor: but first being able to say….here is where buying shoudl take place or selling should take place based on the price the market is setting then moves you to think about the next factors that would influence the buying
[2:06:02 AM] Fetor: candle patterns, chart patterns, trend lines, etc.
[2:06:22 AM] Fetor: this is that part that makes trading hard
[2:07:00 AM] Fetor: so when you get to a point where it is cheap enough to entice buyers you got to take some more steps
[2:07:15 AM] Fetor: cheap enough to POTENTIALLY entice buyers
[2:07:22 AM] Karim: ok
[2:07:23 AM] Karim: i see
[2:07:39 AM] Fetor: but as the price drops lower you can say that the chances for buying increases
[2:07:54 AM] Fetor: there are points where you won’t enter a buy because you know there are better prices below
[2:08:03 AM] Fetor: which we would mark as better entry points
[2:08:13 AM] Fetor: but as the price falls it changes the psychology
[2:08:20 AM] Fetor: it’s economics man
[2:08:26 AM] Fetor: the price then entices buyers
[2:08:31 AM] Fetor: cause we all want to make a profit
[2:08:47 AM] Fetor: so it’s a continuum as the price drops
[2:09:05 AM] Fetor: the cheaper it gets the more juicy it becomes
[2:09:12 AM] Fetor: then when the buying starts
[2:09:17 AM] Fetor: people jump on
[2:09:48 AM] Fetor: they buy it up and that is the demand aspect
[2:09:50 AM] Karim: http://www.screencast.com/users/mugged/folders/Jing/media/6a1acb56-ecee-4aba-8494-17507cbc35c4
[2:09:56 AM] Fetor: as long as there continues to be buyers the price rises
[2:09:58 AM] Karim: this is what i came up with on e/u
[2:10:11 AM] Fetor: until…..it gets too expensive
[2:10:20 AM] Fetor: and people are unwilling to pay a higher price
[2:10:30 AM] Fetor: when that happens
[2:10:31 AM] Fetor: …..
[2:10:36 AM] Fetor: well you know
[2:10:40 AM] Karim: ya
[2:10:41 AM] Fetor:
[2:10:47 AM] Karim: you see the link i sent you
[2:11:13 AM] Fetor: yep
[2:11:30 AM] Karim: is that a spot you would looking 2?
[2:11:35 AM] Karim: or am i missing the point
[2:11:37 AM] Fetor: absolutely
[2:11:46 AM] Fetor: market has set a price there
[2:11:54 AM] Fetor: it’s expensive there
[2:11:54 AM] Karim: ok
[2:12:00 AM] Karim: so
[2:12:10 AM] Karim: if we had a break of that s/r lvl
[2:12:17 AM] Karim: would that indicate a change in sentiment
[2:12:19 AM] Fetor: and as long as there is nothing else to influence people to pay more then it will fall when it gets there
[2:12:35 AM] Fetor: what time frame is that?
[2:12:39 AM] Karim: 4h
[2:12:52 AM] Fetor: i would say yes
[2:13:05 AM] Fetor: that a break there AND confirmation that there is support
[2:13:09 AM] Fetor: that’s why prices return
[2:13:31 AM] Fetor: the price returns to comfort people that people are willing to pay more
[2:13:42 AM] Fetor: so when the resistance then turns to support it’s telling you something
[2:13:47 AM] Fetor: about demand
[2:13:51 AM] Fetor: people will pay more
[2:13:55 AM] Fetor: and now the price is cheap
[2:14:11 AM] Fetor: because the market has set a new price
[2:14:17 AM] Fetor: and the new price is that that is cheap
[2:14:20 AM] Fetor: so people then buy
[2:14:26 AM] Fetor: until it gets too expensive
[2:14:29 AM] Fetor: then they sell
[2:14:38 AM] Fetor: and the process starts all over
[2:14:44 AM] Fetor: and you can do this then on any time frame
[2:14:51 AM] Fetor: all you have to do is adjust your targets
[2:14:57 AM] Fetor: and psychology
[2:15:04 AM] Karim: thats deep
[2:15:06 AM] Fetor: cause lower frames will deal with more static
[2:15:15 AM] Karim: (think)
[2:15:27 AM] Fetor: cause you are tightening the margin for error
[2:15:29 AM] Karim: i get what you are saying
[2:15:48 AM] Fetor: light bulbs go off?
[2:15:56 AM] Karim: yes
[2:15:59 AM] Fetor: ok…good
[2:16:08 AM] Karim: thanks
[2:16:17 AM] Fetor: np
[2:40:19 AM] Fetor: well….going with the expensive/cheap theory….at that point the market has set the price for us and at that point it is too expensive so we should see selling…BUT if there is influence to cause people to be willing to pay more (demand) because they beleive they can make a profit then buying will push the price higher until the market then sets a new price (reference point) as in the example where the previous resistance then becomes support as the market then sets that same point as the new inexpensive price. Once that happens and people are convinced of it, THEY WILL BUY.
[2:42:08 AM] Karim: nicly worded
[2:42:16 AM] Fetor: When that occurs and they enter with a buy they must have an exit and so that exit becomes the point where it is expensive. Now, they may enter out of fear or other reasons, but for the most part the vast majority of players are looking for the maximum profit.
[2:43:49 AM] Fetor: let me make that more clear….they may exit earlier because of fear or other reasons…but the vast majority of traders (institutions driving the market) will be looking for maximum profit
[2:44:58 AM] Karim: and in this case
[2:45:06 AM] Karim: max profit will be the next refrence point
[2:45:08 AM] Karim: right?
[2:46:07 AM] Fetor: in theory yes
[2:46:14 AM] Fetor: but that reference point could be a trend line
[2:46:16 AM] Fetor: s/r
[2:46:24 AM] Fetor: congestion
[2:46:30 AM] Fetor: again…general rules apply here for exits….and because the market is a in motion you have to be flexible and learn when to take profits, when to hold, when to increase position, when to cut a trade loose and reset, etc.
[2:46:32 AM] Fetor:
[2:46:39 AM] Fetor: and that is what takes practice
[2:46:46 AM] Fetor: and what makes trading difficult thing to master
[2:46:50 AM] Fetor: along with the emotions
[2:46:53 AM] Fetor: and psychology
[2:47:04 AM] Fetor: but it becomes easier to master when you understand what is going on
[2:47:07 AM] Fetor: and why it is moving
[2:47:16 AM] Fetor: and what traders are generally feeling
[2:47:18 AM] Fetor: and thinking
[2:47:30 AM] Fetor: then you can adjust accordingly
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