BumaSoft's Market Model

Trading Systems Free Forex Trading Systems
1

This thread is going to be about my understanding of how the markets work. It will be a discussion of principles that work on all markets and all timeframes, based on the application of ideas found in physics and buddhist philosophy. I know that might seem strange at first, but the same principles that apply to our inner and outer reality are the same ones that drive the markets. You don’t have to believe anything I say here. Just filter everything through your own reason and come up with the conclusions. Also, I will never hold that the way I trade is the only way to trade successfuly. There are countless ways of making profits and countless ways of losing money. You just have to pick the ones that fit your personality and taste :slight_smile:

Maybe just a few words about myself might be needed before we start. My name is Marian Busoi, I live in Romania, South-East Europe and have been trading live since 2008. Like most of you, I’ve had my share of bad experiences and my fair share of losses, until I realised that the real path to success must lie in the combination of two factors: proper knowledge (a viable market model) and self-discipline. If you only have one of these, you will still be a loser. Only by a combination of both can you begin to really trade. This is the same as in buddhism, where wisdom or compassion alone cannot bring you towards enlightenment. Both of them are needed, otherwise your bicycle is missing a wheel :slight_smile:

I’ve been a coder for over 10 years. This has been helpful for me in my journey as a trader, because I could quickly test any ideas that came into my head or that I’ve read about on the internet (and the internet is full of junk information on trading, by the way). I’ve coded hundreds of indicators, developed my own strategies and even played around with custom EA’s. Like many of you, I pretty much bought and tried out all the major systems out there, that were marketed online as amazing stuff, along with fake statements. Needless to say, I quickly saw that they are just junk. Maybe some of you had better experiences with such things, but I am only talking about what I’ve personally experienced.

Today I run a site where I share part of my tools for free, along with educational materials and sell part of the indicators and systems. I’m widely known on the forums as BumaSoft. Many people ask me why I sell my stuff. Well, it’s mainly because I wasn’t born rich. I’m self-employed, but I just earn enough to pay my bills, enjoy my free time, practice trading and travel to different places of the world a couple times a year. Right now, I am not that well capitalised, so I don’t have so much money to invest in trading. Selling some of my systems is a means of developing passive income that I can use to fund my trading accounts, until I get to an amount that will allow me to derive all my income from trading. That’s pretty much it about myself and my background. The next posts will be completely devoted to the main topic of this thread: the market model that I use to make sense of the currency markets! Feel free to ask questions any time during this process.

Thanks!

[B]Courtesy of Rob, a PDF of the most important posts in this thread[/B]: here.

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What exactly makes prices move up, down or sideways? What you see on your charts is simply a picture of all the FILLED orders. The market is nothing else but the dynamic of buy versus sell orders, the flow of supply and demand. What is supply and demand?

[B]Supply[/B] describes the total amount of a specific good or service that is available to consumers.
[B]Demand[/B] describes a consumer’s desire and willingness to pay a price for a specific good or service.

At a specific price value, if there is more supply than demand, the price of the good or service will decline, until it meets an area of demand, where people are willing to buy.

At a specific price value, if there is more demand than supply, the price of the good or service will rise, until it meets an area of supply, where there are more willing sellers.

Sometimes, there will be both supply and demand in a small area. This is when price will move sideways or consolidate. Once there’s no more supply in the consolidation area, price will shoot up. Or if demand runs dry first, price will break to the downside.

Let’s sum it all up visually:

Our market model needs to point out how supply and demand shows up on a price chart and get us into trades at moments where either supply (take long) or demand (take short) are FULLY ABSORBED.

In the next lesson, we will talk about the two factors affecting price: FILLED ORDERS (residual/habitual factor) and FRESH/UNFILLED ORDERS (impulse factor).

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There are two factors, forces or energies (whatever you want to call them) driving prices in any given market. Let’s talk about them, one by one:

A. Residual energy

If you play with a piece of iron and a few magnets frequently, eventually that piece of iron will store up magnetic energy. When you place it near other metals, it will act as a magnet. This is what I call residual energy (past actions leaving present tendencies).

In Buddhism also, there are two root factors driving our behaviour: habitual tendencies and consciousness. They are interdependent and condition each other. Every conscious action that you execute is influenced by your HABITS (the unconscious mind). When repeated, conscious actions in turn influence your HABITS and can replace old ones with new ones or create fresh habits. The residual energy of the market is similar to the habitual tendencies that influence us.

In the market, residual energy is simply the imprint of past imbalances between supply and demand. It is the aggregation of all filled orders in the past, which make up your price chart. This whole price history will influence and affect the present and future trading activity. Let’s look at this idea on a price chart:

B. Impulse/fresh energy

If we knew absolutely all the present causes and effects existing in the world, we could predict the future state of the world with 100% accuracy, simply because everything is an effect of already existing causes and conditions. Since we cannot know all the variables (we’re not all-knowing), there will be unforseen/unexpected events happening, which we can conventionally call impulses or fresh energy. This refers to unfilled orders and they are the force that keeps the markets moving. Without these, there’s no more supply and demand and the market would be dead. These unfilled orders are influenced by the filled orders (residual energy) greatly, just like we are influenced by our habits and find it hard to fight them. However, these fresh orders gradually absorb those residual energies, until they are wiped out and the scene is changed. Let’s look at this example:

It is the same example as before, but showing what happened just recently. The first time price met with that residual buying energy, it bounced up for almost 40 pips on this 15 minute chart. Eventually, some fresh supply entered the market, making price revisit that residual energy. On the first visit, most of that energy was absorbed, so most of the buying pressure there was gone. That made it easy for price to break below that price area on the second visit.

So, what we see on the charts is a continuous “fight” between the forces of habit and freshness, a struggle between past and present. Isn’t that what your own life is? :slight_smile:

Anyway, this might be a little hard to understand at first, but take your time to reflect on it. I will be back with more details soon.

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Let’s look at the behaviour of traders and how the order flow shapes the markets. Let’s say the iPhone 5 is perceived as being expensive above the price of 500$ and cheap below 300$. The current price is 450$. The people perceiving the price of 500$ to be too much and the price of 300$ to be very good, will be hesitant to buy the iPhone at this time and demand will start to decrease drastically above the 450$ mark. This will drive prices lower. Once price is say at 350$, more and more of these people will start buying the iPhone, afraid of missing the opportunity. If price eventually reaches 300$, there will be a buying frenzy. The competition to buy will be huge, because everyone is viewing the product as CHEAP and VALUABLE. This will absorb the supply and drive the price back up quickly, unless there’s enough supply there to provide the iPhone to all willing buyers. In that case, after all of them buy at or close to 300$, price will collapse until it finds new buyers.

This is just an imagined scenario of what actually happens in the real world, with normal products we’re buying. The key elements here are these:

  1. There is a certain supply and demand curve in any market. Meaning, relative to current price, you will be able to find a zone above price where the product is viewed as EXPENSIVE (supply) and a zone below price where the product is viewed as CHEAP (demand). The closer price gets to that demand zone (low on the curve), the more buying pressure is increasing. The closer price gets to the supply zone (high on the curve), the more selling pressure is increasing. This is one of the reason why 50% fibs work so well. In the middle of the supply and demand curve, price is seen as neither EXPENSIVE, nor CHEAP, thus there will more than often be a temporary balance between supply and demand and therefore, a consolidation. Depending on the trend of the market and the strength of supply versus demand, price will break to one direction or the other (up or down), to test the top or bottom of the curve.

  2. Human psychology plays a huge role in the markets, which are actually a reflection of mass/herd psychology. Learn how the herd thinks and you will be able to profit from that knowledge.

  3. We should be interested in buying cheap and selling expensive, so we should BUY as price declines and SELL as price rallies! This is the opposite to how most traders behave, but if you were trading iPhones instead of EURUSD, you would definately understand this simple thing. You wouldn’t buy the iPhone after a rise in price, would you? You always look for cheap prices when buying goods and always try to sell as expensive as possible when you sell your goods. If you think the financial markets are any different, consider the possibility that you might have been brainwashed :slight_smile:

  4. In the electronic markets, we can use limit and stop orders, so if a group of traders wants to buy EURUSD in a certain area that spans say 20 pips, some of them will place a pending limit order at a price level inside that area. Not all of these limit orders will be triggered, because price might not reach all of them before it bounces up. Some of these orders will remain there, creating the residual energy we talked about. On the next visit of price in that area, it will trigger the orders and thus find demand. If there isn’t enough supply to absorb all that demand, price will bounce again.

Slowly read and digest all this information. There is much more to cover and then we can go on to discuss charts.

Cheers!

5

If you take a long position you’re a bull. If you take a short position, you’re a bear. That’s common knowledge for traders. And it’s wrong! Let me explain.

If Trader A is LONG the EURUSD, what is he now looking for? Does he have an objective or is he just playing? :slight_smile: Why is he LONG in the first place? The answer is that he entered his position in order to exit and take his profits somewhere higher. Whenever he exits, that means he SELLS. Your take profit order for a BUY position is a SELL order. This makes Trader A an active bear, because he is constantly hunting for a place to SELL.

So, as price rallies up, always know that there were buyers all the way from the bottom up to current price and all those buyers that are still in the position are active bears. They want to take profits. The higher price rallies, the bearish it becomes. Hence, it’s always a bad idea to chase price and buy high. I am not saying you should fight the trend. What I am saying is that if you want to join an uptrend, you first wait for a retracement/correction/decline in price and you buy into the trend as price declines. This will ensure that the odds are on your side, not against you.

Impermanence is the primary principle of Buddhism. Everything changes. This also holds true in the markets. Just because price is rallying, do not assume that it will rally forever. Same thing if it’s moving sideways or dropping. While price is moving sideways, you should be planning your longs and/or shorts. While price is moving up, you should plan your SHORT. While price is dropping, you should plan your LONG. Markets continually shift between moves up, down and sideways. We are wired to EXPECT things to be permanent. You need to rewire your brain to EXPECT CHANGE and be prepared for it.

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Welcome to BabyPips, BumaSoft/toplessons. I like what I’ve read so far, please keep up the good stuff!

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Thank you for the warm welcome, T-Forex :). I will continue shortly. Enjoy!

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Do you favor trading breakouts?

And I appreciate your analysis of how the market works…very accurate.

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Hi, pipcompounder. Thanks as well…

Personally, I rarely trade the breakouts, but they can be perfectly ok as a trading strategy, depending on the implementation. If your analysis shows that after price has rallied and hit a supply level, that supply is being absorbed, then it’s a safe bet to trade that breakout to the upside. The only downside to this is that you don’t really have a logical point to place your stop loss at. A logical stop loss would be under a LOW and that will probably be way down. For this reason, your timing has to be very precise if you intend to use a tighter stop. Below is an example of the most recent breakout trade I took a while ago on a 1 minute chart of EURUSD:

You can see that after the time I sold short, there was no adverse excursion (negative pips) above my entry. At that time, I had determined that all demand in that area has been absorbed. That allowed me to use a tight 5 pip initial stop and exit for a profit of 12 pips at a point where I determined there will be demand.

To keep it short, I am not against breakout trading. It can be very profitable if you have the correct principles behind your analysis and that’s what I want to share here. How you make use of the principles that drive the markets is a matter of personal choice. Thanks and let me know if you have any more questions.

Good trading!

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Let’s dive deeper into the concept of residual energy with a real EURUSD chart example:

In the chart above, I am looking at the latest rally, where I marked the areas of consolidation which will leave behind residual energy that will influence future prices. Now, I won’t go into the details of identifying the areas and measuring the energy in them yet (I will do so soon), for now just think about it as small consolidation areas, which show a balance between supply and demand and are the origin of a decent break outside of them. Now, let’s assume that we are expecting price to drop. We want to know where it might stall or bounce on the way down. If no fresh energy would enter the market, then it would all be a play of residual energy and we can just mirror the rally in the future and know what will happen. Price would react at the exact same areas and the magnitude of the bounces would be close to the magnitude of the first rally out of a past consolidation area (until it consolidates again). We would almost have a mirror of what happened in the past. I say almost because the current moves lack the fresh energy that the past moves had (remember we are just pretending that the market is only moving based on residual energy in this example):

In the screenshot, I also marked with a green up arrow our highest probability LONG in this area. I will explain later why this and not the other consolidation areas had the most residual energy attached to it. Now, let’s see what actually happened in the real market:

Due to fresh energy entering the market, even though price DOES react in the same places as in our pure residual energy model, it isn’t quite the same, especially time-wise. Our highest probability LONG, however, would still travel nicely from entry to target. As you might suspect, this isn’t always the case, for if it was, we’d have ourselves a Holy Grail right here :). The reason why it doesn’t happen based on our pretended residual energy model is because of fresh energy. What we will learn to do here is to monitor the flow of fresh energy turning into residual energy as close as possible to the time when our preplanned orders get triggered. By doing this, we can assess if our pending order is still high probability or not. This also will not ensure 100% win rate, because we don’t have any control over what happens after the point of no return (after an order is triggered). Our job is to make sure the probabilities are on our side upto the moment when we enter trades, then wait for our plan to unfold. Long time before our trade is entered, we will have a detailed plan, describing where we should exit for a loss and what our targets are.

Sorry if it’s too overwhelming so far. If you want me to clarify anything, just let me know.

PS: Don’t jump on me for using historical charts. We will get into live charts very soon. Right now, we are just going through the concepts and logic of the model.

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Now it’s time for the dirty business :slight_smile:

The first step to making use of the principles we just discussed is to figure out how to spot residual energy on a price chart. Here are a few ideas:

  1. High residual energy must originate from price zones in the past that generated energic/powerful/strong moves. The greater the energy, the greater the movement, right? That’s also true in physics. The greater force/energy you apply when hitting a ball with your foot, the greater the movement of the ball will be. If you use little energy, there will be little movement.

  2. Kynetic energy (actual energy, energy of movement) is an actualization of potential energy (unmanifest energy). In other words, strong moves up or down in any market always originate from areas of seeming equilibrium, i.e. areas of consolidation (price steadily moving up and down in a tight sideways channel).

Now, it’s pretty easy to identify such areas on a price chart. In the chart below, I marked all residual energy areas. In the next posts, we will look into measuring the actual amount of energy inside any given area, so that we only make use of the strongest. We will also look into proper identification of the CORE energy area inside a consolidation.


Just click the picture to see it in full size. I uploaded it to my website. If anyone knows how to upload proper sized images to babypips, let me know… Take your time with the image. With X signs, I marked where a specific energy area is absorbed.

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Use TinyPic - Free Image Hosting, Photo Sharing & Video Hosting

And then post them using the IMG placeholders

And… I love this thread => Many things you are talking here, I too am interested in + looking into them too myself.

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Very nice. I am trying to do something similar like how you did manually (and perhaps with more accuracy!). I hope you can give your input and insights into this, as I’ve done a lot of research (one can review them in my thread);

What I am trying to do is to do ;
1-proper identification high residual energy; I currently identify them using high peak volume. IMO high volume = high energy
2-projections like those X sign areas, after point 1 is done correctly
3-automate the process
4-gather the statistics

Would love to hear your views. Your so called ‘concepts’ are actually sound and reflective upon actual market reality; because this is really how the market works.

So, in a sense, you do have my attention and vouch already => Welcome to BP!

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Hi, Relativity!

First of all, thanks for the nice comments and warm welcome. Also, thanks for the tip about tinypic. It’s a shame the attachment system on the forum itself isn’t up to it.

I will certainly have a look over your thread and give you some feedback. You are indeed up to something. Volume can help to identify the areas too, but I prefer to just use the price data and I have about 8 main factors I look at to measure the amount of “energy” inside each area. I will get into that later in this thread. As you know, we don’t actually have real volume in the Forex market, it’s just based on tick data. Nevertheless, I’ve used VSA in the past and it’s a viable strategy even with tick volume. Anyway, I will check your thread and get back to you with more thoughts after that.

Regards!

16

Sometimes, these consolidation areas will be too wide, making the risk too big for us if we entered a trade while placing our stop on the other side of the area. This being the case, we have to see if there is a way to tighten that zone and find the “meat” of it, the core, the part with the most residual energy stored into it.

Let’s look at a chart:



(Click picture to enlarge)

Here, we have identified an area of residual demand energy. It is merely an area of 9 consolidating candles, out of which price then breaks to the upside. It’s 35 pips wide, so if we enter LONG on the first test, we would enter a limit order at the top of the area with a stop loss a couple pips below it. Depending on the broker spread, we would probably risk 40 pips on this one. Our first target will be the next decent consolidation area that manifested on the way up in the initial move. It’s 45 pips, so our risk:reward is just a tad over 1:1, which isn’t quite good. We like to enter trades with at least 1:2 risk/reward. The final target would be the next consolidation, which is way up at +100 pips in profit. Is there a way to decrease our risk on such trades and increase rewards? Yes, we can tighten the area so as to match MOST of the trading activity inside it. Here is the result:



(Click picture to enlarge)

What we have done here is modified the upper line. We ALWAYS play around with the line that is closest to price (this is very important). The line most distant from price is used as a stop loss. If we alter that, we will get stopped too often! The extremity of the area which represents our entry point can be altered for the purpose of tightening risk per trade and maximizing profits. In this case, we reduced the stop loss by half, have a first target of 1:3 and a second target of 1:6! This would be an excellent trade.

By the way, right now we haven’t gotten into measuring energy, so for now, just take my word on it that this would have been a good trade. We will later see why. For now, practice identifying these consolidation areas from which sharp moves in price originate and try to tighten them. The “meat” of an area usually includes just the bodies of the candles and can ignore the wicks. In this example here, I actually cut through two of the bodies, because those two candles added together actually form what you call an in inverted hammer :). The part that was excluded can be considered a wick. This isn’t 100% science, so it requires a lot of screen time and practice before you really master it. Just look for multiple candle opens and closes in the same area and try to include all the bodies.

In the following days, we will get to measuring residual energy. Step by step, we will learn to build a proper CORE trading plan together, using these fundamental principles of all markets and timeframes. Just be patient and take your time with learning these concepts. Any questions are always welcome.

Cheers!

17

Measuring the amount of “potential energy” inside an area of supply/demand balance is a crucial aspect of trading using this model. There are 8 main factors I look at to achieve this measurement, plus one extra factor.

Main factors are:

  1. Angle of original imbalance
  2. Profit potential
  3. Price-wise Absorption
  4. Time-wise Absorption
  5. Fractality
  6. Fresh obstacles
  7. Bricks upon bricks
  8. Freshness

The extra factor is corelation. Each of these will be scored according to importance and by summing up the scores, we get the energy measurement. I will discuss each factor in detail starting with the next post. Is anyone still reading this thread? Shall I continue? :slight_smile:

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Yes I am => Please do continue!

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If there’s one person benefiting, then that’s good :slight_smile:

Probably the most important factor is the angle of imbalance. Let’s look at a few examples to show you what I mean by this:

A. The 90 degree angle - the GAP - Very strong move

I consider GAPS 90 degrees. These are the greatest imbalances and can provide us with the highest probability trades:



(Click to enlarge)

These are more frequent in Stocks, Commodities, Indices or Futures Markets than in Forex, but when you do find them, they are as close to “easy money” as one can get (though I hate that combination of words), if you know what to look for (find the residual energy at the origin of the gap). Often times, you will miss the entry if you try to tighten up the zone as we discussed in the previous post, because the energy is so great here that price will barely touch the original consolidation and quickly turn around. You will just have to determine if the profit potential is worth it if you enter the trade with a stop on the other side of the consolidation. If you have at least 1:2 risk/reward, then it’s good. If not, tighten up the zone and if you miss the trade, that’s ok. More opportunities will follow. We will get into money management much later though.

B. 80 degrees - Very strong move

These are actually close to 90 degrees, but just for convenience, I consider them in the 80 category (if the move is composed of multiple bars, it isn’t really 90 degrees, just very close), mostly because they aren’t gaps, just high range candles:



(Click to enlarge)

Like before, the first bounce usually takes place at the consolidation boundary that is closest to current price. However, you can more often than not successfully trade the tight core energy area also:



(Click to enlarge)

C. 45 to 80 degrees - Gradual move, medium strength



(Click to enlarge)

D. Less than 45 - slow move, weak energy

I don’t look for trades based on such levels. Sometimes they work, sometimes they don’t, but most often than not, even if there is a bounce, price will first spike beyond the level and stop you out first. This often happens because price needs to reach a stronger residual energy area to make it turn, like in this example (just look to the left, just a tad below the failed area):



(Click to enlarge)

So, there are 4 categories here: gap, series of high range candles, gradual moves and weak moves.

A weak move will mean a score of ZERO for this factor.
A gradual move will be a score of 1.
A strong move (high range candles) is a score of 2.
And a gap is a score of 3.

This doesn’t have to be taken as law. What I hope you will take from these posts are principles. The principle here is that the greater the move coming out of a residual energy area, the greater the energy stacked in there. You can then grade this strength of initial move however you like. You can look at the angle of the move, the speed (pips/time) and the wicks (we’ll go into the wicks part later, when we talk about absorption).

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Can I sum up the principles in this manner?
1-Identification of original strong moves / imbalanced moves slowing down and beginning to tighten
2-Identification of core energy / residual energy / acceptable consolidation areas
3-Strength of the follow up breakout; using speed / angle of price over time
4-Projecting forward price zones for price to bounce upon

IMO, the problems I see that can put off most traders are;
a-correctly identifying each step
b-ensuring each step flows and relates to the previous step and future step
c-accounting for failures that break down the flow of steps 1->2->3->4

I think there are ways to at least mathematically quantify and measure the results of these principles (not the principles itself thou) e.g.
-For 1; High tick volume candles or high range candles compared to previous candle, maybe at least x2 longer in length as a qualification
-For 2; Counting candles in a range bound; the more candles, generally the better?
-For 3; Using angles; this I do agree since there is some element of numbers involved. We now know at least where the starting point of the angle be; at step 1. This leads to the question of where does it end? I am thinking it ends when there is an acceptable degree of change of angle, comparing the current angle VS next angle.
-For 4; Again, using candle counting; how far timewise do we project? Is there a time decay factor in play for the zone projected forward? What kind of price moves cause the zone to expire (strong price move qualification needed; see ‘For 1’)?

I am speaking in context of Ray Barros’s and Michael D Archer & James L Bickford’s work (and maybe my own as well).

Of course, I do not assume these principles are law. But if statistically speaking if these qualifications show at least a 60% significance, then its good enough to be considered a trading edge => I view statistics as a close approximation of reality; in fact, this is how scientists make and declare major modern discoveries e.g. the search for Higgs.

21

Good, post, Relativity. Thank you for the input. I don’t use tick volume myself, but you have touched on some of the other factors I’m about to discuss next :). So this strength of imbalance is only 1 out of 9 factors I “rate”/“score” to determine the probability of a bounce from an area. I will get into the other factors soon and maybe after I list them all, we can have a discussion and see how/if we can improve on the measurements. Do we have a deal? :slight_smile: