Market Geometry — What Is It, and How Is It Used?

Market Geometry — What Is It, and How Is It Used?

[Update September 30, 2020]

The purest form to interpret the price action, market geometry sits at the base of technical analysis. It uses consolidation areas from the past as well as past price behavior to project high-probability levels where the market will react. Since the moment the market was born, traders began to notice that prices followed certain patterns. Thus, mastering market geometry Forex principles means an increased probability of making the right decisions and opening profitable trades.

We’ll discuss what is market geometry in a nutshell, and the most effective market geometry trading methods and concepts.

Market Geometry, and how do we define it  

Basically, market geometry is a whole framework for working with two key elements: time and price. It is simply not acceptable to use each of these elements in isolation, as it is the observation of the price and time interaction that allows us to observe the nature of trading and identify the most significant levels for opening and closing positions.

The main thing in the trader’s work is to learn how to link all these parameters depending on the market context. After all, the formation of accumulation areas at a certain level can occur both for a fairly long period of time, and for a very short time. 

Forex Market Geometry

So, the market geometry framework gives you a whole set of tools and concepts to analyze the price/time interaction depending on the market conditions, as well as your experience and abilities. 

Thus, market geometry, in fact, is a collection of methods of technical analysis of all aspects of market behavior — patterns, price dynamics, trade volumes, types of transactions, and in general any information that can be obtained. 

Below is an overview of the popular components of the market geometry. There are books written on some of them, so it is impossible to give a detailed review within one article. The purpose of this publication is to interest you and encourage you to further study the materials on the tools you like. 

Psychological levels, and where to find them 

Everyone who has spent at least one day on the trading platform is aware of the support and resistance levels. But even experienced traders can’t always answer the question of why these levels are where they are. 

Levels are created where traders are most active and where they buy and sell their assets on a massive scale. If you look carefully at the trend reversal points, support, and resistance levels, you can see that often all this happens near the round numbers: 1.23000, 78.500, and so on. For example, when the EUR/USD reached 1:1, the pair has been moving back and forth for over two months. Each trader wanted to stay in the winnings and to fix the currency either above one unit or below, which is at a psychologically important level, after which the winner will be determined implicitly.

When the price is fixed above or below a strong level, it is extremely difficult to break the trend. In order for the scales to sway in the other direction, you often need to get some resonance news or certain steps of the national regulator: currency issue, bond buyback, change of the interest rate.

There is an explanation for this. Ask 10 people how much their phone costs. You may be given figures of 300 USD, 500 EUR, and so on. It is unlikely that someone will name the price of $299 and 99 cents, even if they bought a phone at this price. For the same reason, the prices of rental apartments are rounded, and meetings are scheduled at half-eight in the evening, and not at 7:43 PM. We are not robots, we try to round up the numbers, and it is normal. 

Similar processes unfold in trading. Traders who trade currencies leave orders to banks or other intermediaries to put in the system 1 million EUR for sale at 1.1800 USD.  Such a figure is simply easier to work with. Therefore, a lot of buy and sell orders accumulate near the round markers.  There are always solid volumes, strong levels, and reversal points. 

Therefore, it’s usually a wise decision to be careful with trades when the price approaches the round markings, and do not rush. There may be price breakdowns, rebounds, reversals, and all sorts of things. By the way, here is a perspective on the phenomenon of reverse psychology in Forex trading. 

Market Geometry — Psychological levels

Elliott’s Wave Theory, and the basics of it

The wave theory was developed by Ralph Elliott in his 1938 study “Principles of Waves” and is widely used in geometry trading. But it was Robert Prechter who managed to really glorify the theory. Based on it, Prechter predicted a stock exchange boom of the late 1970s and the collapse of 1987. 

The key concept of Elliott’s theory is based on the statement that any change in price occurs on an 8-wave model. If you determine exactly where it starts, you can very likely determine whether prices are going down or up. 

Based on the fact that all events occurring in the stock markets are cyclical, Elliott has developed a consistent pattern. In his theory, he presented an 8-wave model with 5 impulse waves and 3 corrective waves, which move backward from the impulse. All the fluctuations in this model are the result of the confrontation of the exchange market participants and therefore can be predictable.

Market Geometry — Elliott's Wave Theory

In the classic Elliott’s Wave Theory, there are several rules for marking out waves.

  • The 2nd wave cannot be larger than the 1st wave and cross its starting point.
  • The 3rd wave is the largest of the five waves in the trend. 
  • The 4th wave should not cross the top of the 1st wave. 
  • The 5th wave cannot be larger than the 3rd wave. 
  • After five waves, the trend is followed by three waves against the trend, A, B, and C.
  • Each of the waves may consist of sub-waves that follow the above-mentioned marking rules. 

One of the disadvantages of this theory is the difficulty in determining the beginning of the wave pattern. When applied to the Forex market, where the picture changes every second, this theory is usually used by experienced traders with years of successful trading practices. You can read more about Elliott Wave Theory here

It should be noted that traders are increasingly combining Elliott Wave Theory with various technical indicators in order to increase the success of the forecast and reduce possible risks. Among such instruments, Fibonacci levels are one of the most common. 

What are Fibonacci levels, and how they are structured

Fibonacci levels are based on a mathematical theory that was created by an Italian scientist Leonardo Pisanski back in the 12th century. This theory is widely used beyond exchange analysis, and the Fibonacci pattern is also found in many natural elements.

Each of the Fibonacci tools is based on a sequence of the species 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89. Each number in this sequence is equal to the sum of the previous two. When dividing any number of the sequence into the previous one, we get about 1.61, and this value is used as the main coefficient in the construction of all graphical Fibonacci instruments.

Fibonacci levels are used to predict further price movements of an asset. As a rule, when working with such indicators, a binding to an already existing trend is used to predict either its further development or correction. Fibonacci indicators provide guidance on the purpose of the movement: to which price level the price is likely to reach, where it will turn, etc. Based on these objectives, traders set pending orders for market entry, as well as stop loss and take profit levels.

Fibonacci Levels, or Fibonacci lines, are one of the most popular Forex market geometry indicators. They look like a grid of several lines located at a distance calculated with the help of the Fibonacci coefficient. As a rule, these lines are the key levels for the price that tends to them, often changes its direction when approaching this level, and its breakdown, on the contrary, signals a strong trend.

Market Geometry — Fibonacci levels

image source: https://forex-strategies-revealed.com/

When drawing Fibonacci lines, they are bound to the last explicit trend. The grid from level 100 (trend end) to level 0 (trend start) is stretched from the beginning to the end of the trend. Thus, the levels located within this range (61.8, 38.3, etc.) become reference points for possible correction, and the levels after 100 (161.8, 261.8, etc.) become reference points for a trend continuation.

When conducting trend trading, you can put a stop loss on internal levels, and take profit on external levels. When trading on a correction, take profit is put on the internal levels. You can also open deals on breakdown levels by placing pending orders on them.

Here you can read about how to combine Fibonacci methods with Elliott Wave Theory.  

What is Andrews Pitchfork, and how to use them

One of the most used market geometry was created by the representative of the classical trading school Alan Andrews. This method of profit extraction is widely known as Andrews Fork. Graphically, it really looks like an agricultural implement. It should be noted that Andrews himself earned a decent capital of more than a million dollars with the help of his brainchild.

Initially, you should determine the location of three reference points in a trend. The first point A determines the beginning of the movement. Since the trend is downward, the second step B will be at its minimum and the third step C will be at its maximum. The distance between the last two points is divided into half. Then a midline is drawn through this middle and point A. After that, parallel lines (which are the side teeth of the forks) are drawn through points B and C. These lines also represent the support and resistance levels.

Market Geometry — Andrews Pitchfork

image source:

Andrews Pitchfork can be used at any time interval, starting from a 15-minute timeframe. It should also be kept in mind that Andrews Pitchfork is much more productive on older timeframes. Andrews himself has proved a number of his price trend observations. They are not a dogma but can be useful for any investor. By using these rules in combination with other technical indicators, you may significantly improve your forecasting results.

  • According to Andrews, there is an 80% probability that the price of the asset is repelled from the midline or from the extreme levels, going back inside the forks.
  • Sometimes after returning to the midline, the price makes a few oscillations around it, breaking through it from the bottom up and down again from the top down.
  • When the price reaches the upper or lower boundaries of the pitchfork, a reverse turn to the midline is always possible.
  • Sometimes, the price makes a false breakthrough in the upper or lower channel level, going back to the middle line. But if at least two candlesticks close after the channel border breakthrough, the trend reversal is possible.

This article describes how to use Andrews Pitchfork to identify strong trends. 

Gann methods and they connect price and time

Gann theory can be described as research on price and time ratios, and how these ratios affect the market. The Gann theory considers price and time as key elements of FX market geometry and is used in predicting future market movements.

Market Geometry — Gann methods

image source: https://www.sacredscience.com/

William Gunn was among the first analysts to understand that the psychology of market participants underlies its movement. In most cases, investors always repeat their actions. With this in mind, the author has built his theory on several components. 

  • Analysis of historical data, which is used to identify situations that are likely to be repeated in the future.
  • Price corridor. The most important components of the described method, support, and resistance levels, are analyzed. Near these limits, the behavior of market participants is changing. Accordingly, the trend direction changes as well.
  • The trading plan implies a systematic analysis. It takes into account all possible factors that may affect the trend change. The development of possible variants of trading actions according to a certain algorithm is carried out.

Competently using Gann Methods, any trader is able to efficiently predict the further movement of the price trend of his chosen currency pair.

Conclusion

The above is a general overview of Forex geometry principles. Each of the methods described above deserves a deep dive if you plan to master them at a high level. The more knowledge you have about the different aspects of market behavior and trading geometry, the better and more effective you will be at predicting. 

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