I´ve got some questions concerning forex market structure. Let´s just start with:
1.) What does it mean if the price goes up or down? - In normal world, price is usually based on quantity. If there is enough corn, the price goes down because everybody has a lot of corn and they want to get rid of it so they have to decrease the price. But in forex market is not based on quantity. If I want to buy such a big size that would move 1 pip at a moment, somebody has to sell it to me. If this happens, market cannot move in any direction, correct? If for every buyer there is a seller, then how the market moves?
You’re on the right track. This is only my opinion but if forms the basis of how I trade.
Say you have the property market, a bunch of houses. The smart investors buy at the low price. Then there aren’t any more houses, so they have to mark the price up. They profit. The not so smart are buying after price has moved up, at the very top, they’re trying to jump on the band wagon.
At this point, the smart investors are selling, taking their profit. Then there’s no more to sell, an over-supply, and prices come down, and we repeat.
So it is all about supply and demand. I’d recommend having a google for “Wyckoff Schematic”… it explains it a bit better with a couple of diagrams.
Your reference to “quantity” refers to supply, and that’s only one side of the supply/demand equation.
But, there’s a larger issue here, and it’s this: Supply and demand in the forex market do not mean what they mean in the agricultural commodity market. So, let’s not get bogged down in your corn analogy, or the previous poster’s housing analogy.
Supply and demand in the forex market refer to the preference of one specific currency over another specific currency; and, therefore, supply and demand have nothing to do with “quantities” of money in circulation.
Let’s use an example which avoids all preconceptions about what particular currencies might be “worth”. In particular, let’s avoid using the USD — the bully-currency, which is the world’s reserve currency — in our example.
So, just to illustrate the dynamics of supply and demand, let’s use an extremely obscure currency pair —say, the FCR/KDK.
We traders use some very careless terminology in discussing our market. We tend to refer to going LONG a currency pair as BUYING that pair; and, by that, we mean that we expect the pair to INCREASE in price, thus earning us a profit. Furthermore, we tend to refer to the “pressure” to go LONG as "buying pressure. And, conversely, we refer to the pressure to go SHORT as “selling pressure”.
All of this [I]appears[/I] to make sense, until we realize that there is no buying or selling of currencies or currency pairs in the forex market, and our loose terminology is simply causing confusion.
Instead of “buying” and “selling”, what we’re actually doing is betting on the relative worth of two paired currencies. Returning to our FCR/KDK example, when we go LONG, we are simply betting on the proposition that (1) the FCR is going to gain in worth with respect to the KDK in the near future, or (2) the KDK is going to decline in worth with respect to the FCR. And, on the flip-side, when we go SHORT the FCR/KDK pair, we are betting that the opposite will happen in the near future.
Note that this scenario does not involve the [I]quantity[/I] of either currency which happens to be in circulation, and it does not involve the [I]absolute worth[/I] of either currency as measured against some world reserve currency or other international benchmark.
Both currencies in our example could be absolute [I]dogs;[/I] but, if the FCR was judged to be less of a dog than the KDK, then a LONG position in the FCR/KDK pair would be indicated.
On the other hand, both currencies in our example could be extraordinarily [I]strong[/I] as measured against all the other currencies in the world; but, if the KDK was judged to be stronger than the FCR, then a SHORT position in the FCR/KDK pair would be indicated.
When a majority of market participants judge a LONG position to be indicated, the way they position themselves in the forex market (by placing orders to go LONG) exerts “buying pressure” on the pair in question (and there’s that loose terminology again, implying “buying” or “selling” of a currency pair).
Alternatively, when a majority of market participants judge a SHORT position to be indicated, their orders to go SHORT exert “selling pressure” on the pair in question (loose terminology again).
All of that description was offered to set up this question: How are “buying pressure” and “selling pressure” accomodated by the market?
Very simply, the spot forex market is [I]made[/I] by market-makers, who — [I]trading for their own accounts[/I] — offer BID prices and ASK prices to the market, in an attempt to profit from both LONGS and SHORTS who trade with them. And this is possible ONLY if these market-makers are able to keep their own positions — as counterparties to their LONG and SHORT customers — relatively balanced. And this, in turn, is possible ONLY by adjusting their BID and ASK prices, on an almost continuous basis, to eliminate imbalances between “buying pressure” and “selling pressure” in the orders flowing in to them.
So, if a majority of traders believe that the FCR is going to appreciate with respect to the KDK, then their “buying pressure” will exceed the “selling pressure” of the minority of traders who have the opposite opinion. And the market-makers (brokers) receiving their orders will be able to balance these pressures (and therefore balance their own positions internally) ONLY by pushing their BID and ASK prices higher.
To summarize all of this, “demand” for a currency pair means pressure applied by traders who want to establish LONG positions in that pair. This demand is based solely on the belief by those traders that the base currency is going to be worth more than the cross-currency, in the near future (and by their willingness to put their money where their mouths are). In response, market-makers (brokers) increase the “price” of the pair, by increasing the BID and ASK prices which they offer, in order to avoid being put into an overwhelming SHORT position by the “buying pressure” coming into the market.
Oh, one other thing. You may be wondering what the FCR/KDK pair is, exactly.
It’s the United Federation of Planets [B]Federation Credit[/B] (FCR), versus the Klingon Empire [B]Darsek[/B] (KDK). Yes, these are fictitious currencies (from the world of [I]Star Trek[/I]); but, they [I]could[/I] be traded, if brokers offered them, and if they had nice-looking charts!
The point here is that these imaginary currencies have no “quantity” in the commodity sense, because they don’t even exist. And yet, traders could exert “demand” for the FCR/KDK pair, by ganging up on the LONG side. Or, they could flood the market with “supply”, by ganging up on the SHORT side. And market-makers would have to adjust their BID and ASK prices for this fictitious pair, or face potentially heavy losses from the demand/supply imbalance.
And there you have the force driving a change in price.
thank you so much for taking time to sit down and write this for me. I really appreciate it.
However, your analogy is maybe too general. Let me put it this way and please correct me if I am wrong. I´ve got this information from ForexFactory member DarkStar, but I´m not sure if I get it right.
The price of let´s say EURUSD went down one pip from 1.3254 to 1.4353. What happened? In order for the price to drop 1 pip, there must have been somebody who sold EURUSD in an amount that was too big to be filled from actual long orders at that price. So, the SELL order at 1.3254 consumed all the buy orders at 1.3254 and still wasn´t completely filled so the price had to drop 1 pip lower, where were other BUY orders. If there is still not enough BUY orders at 1.3254, the price will drop another pip for more BUY orders.
I’m familiar with the FF posts you are referring to. [I]Darkstar[/I] (real name Daemon Goldsmith) wrote a long and detailed description of forex market structure, which he posted in 7 consecutive posts in the [I]Forex Factory[/I] forum, 8 years ago.
Five years ago, I recommended that [I]Babypips[/I] members study his work; and I still recommend that today.
Where [I]Darkstar[/I] and I disagree, it’s probably a matter of semantics, more than anything else.
For example, [I]Darkstar[/I] says, “Every time you see price move a single pip, it means that an order was executed that consumed (or otherwise removed) the open interest at the current price. There is no other way that prices can move.”
And I said, in my previous post, “…traders could exert “demand”…by ganging up on the LONG side. Or, they could flood the market with “supply”, by ganging up on the SHORT side. And market-makers would have to adjust their BID and ASK prices for this…pair, or face potentially heavy losses from the demand/supply imbalance. And there you have the force driving a change in price.”
We could probably write another long post discussing the similarities and differences between what [I]Darkstar[/I] said and what I said. But, I think we’re dealing with two sides of the same coin. I hope you agree, so that we can skip another long post.
It’s interesting to note that [I]Darkstar[/I] has stated categorically that the top-tier banks in the interbank network are not market-makers. He must be using a different definition of “market-maker” from the one that I use, because to my way of thinking, any entity — broker or bank — which offers BID and ASK prices for any instrument, and adjusts those prices to balance supply and demand, is making a market [U]as a market-maker.[/U]
Here again, it just may be a matter of semantics. [I]Darkstar[/I] seems to refer to the [U]same banks[/U] as Tier-1 banks when they are transacting at the interbank level, and Tier-2 banks when they are transacting downstream (say, with your retail forex broker). In my view, if Deutsche Bank (to use an example) offers wholesale BID and ASK prices to FXCM, and then FXCM marks up those wholesale prices and offers retail BID and ASK prices to you — both Deutsche Bank and FXCM are acting as market-makers.
Long-story-short: If you like [I]Darkstar’s[/I] way of describing forex market structure, study it and make use of it. He won’t lead you astray.
On another topic altogether, I’m disappointed that [I]Darkstar’s[/I] “signature” no longer appears on his FF posts. I always liked his signature: “All your stop are belong to us.” — which is a take-off on the now-famous expression All your base are belong to us
Finally, Daemon Goldsmith I[/I] is the author of [I]Order Flow Trading for Fun and Profit[/I] — which I have not read — but you might want to track down, if his way of presenting things blows your skirt up.