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Auction Market Theory + Supply and Demand ETHUSD
I have tried to move away from indicator based trading into more fact based TA and would like to breakdown how to use this form of analysis with just candlesticks and volume. This is a larger time frame breakdown though similar patterns can be identified (though significantly more volatility prone) in smaller time frames and one can find that these principles explain moves across many markets. What's interesting with Ethereum is the similarities to precious metals. The demand has no specified cap while the supply is limited. Using supply as a constant and demand as dependent variable paired with a basic understanding of auction market theory, each move in an asset can be analyzed. I only chose ETHUSD due to the rising buzz around cryptocurrency.
There are 3 main discussion points in this post They are numbered on the chart in order and the numbers will also be used to tie them to their principle.
1. Aggression: Who is currently more aggressive in the market? Buyer or sellers? Aggression in markets simply is the continued buying or selling at higher or lower prices respectively, causing rapid fluctuations. I try to mark the more significant areas of aggression as they often have more importance in the broader scheme of things. For ETHUSD, in 2021, we have seen tons of buyer aggression causing large breakouts, often followed by selling aggression after new highs are created. These types of moves can not be predicted, nor can we establish how long they will carry on, though after the fact they are of upmost importance. For reference, (1), (2), (4), (5), (6) are all areas of aggression I identified on this chart. To identify these I look for volume that is relatively higher than usual as this shows the increase of interaction between buyers and sellers. I then find the bias which is simple on a candle chart- red or green. Typically with larger aggressive moves there is a scenario that occurs referred to as imbalance. An imbalance is formed when buyers raise the bid or sellers lower the ask quickly creating larger fluctuations in prices. These imbalances are often POI's during a retrace.
2. Absorption: Absorption is when there is a large group of resting limit buy or sell orders that temporarily or fully halt selling or buying action. This information can be accessed in real time with level 2 data in the stock market though I'm not to sure how to identify them best real time in the cryptocurrency market as it is decentralized. Though absorption isn't dependent on aggression, it can easily be identified when there is an aggressive party in the market. First, the assumption must be made that prices with downward/upward momentum will continue in the same direction as long as the majority of the money in the market retains bull or bear bias. Theoretically, one must assume that as long as there is no worthy contest, prices will remain moving to infinity or 0. Second, the study of volume. If there is an obvious directional movement, volume is continuing to increase, and prices are unchanged as buy/sell pressure continues, then it is safe to assume that there is larger amount of limit orders than active/aggressive orders, in a nut shell that is all absorption is. Example- [ (1), (2), (6), (A), (B)(ABSP1) (ABSP2)] . What happens next is a competition of the buyers or sellers for the best possible prices and trends form in that direction until their position is fully formed, example-(COMP). Absorption areas are often referred to as support and resistance and in a consolidating market these areas are easy to identify. They often creating a mix of limit buyers/sellers along with "market" buyers/sellers resulting from the fact that both of these parties have identified these levels and they both are in agreement that it is a buy/sell zone [(6)]. If these supports and resistances are broken (typically a result of aggression) those on the sidelines may see a chance to enter the market causing aggression/breakouts, for example- (5).
3. Supply and Demand- Supply and demand is essential for understanding any market and is arguably the biggest influence on price. When it comes to understanding demand in the form of Cryptos or any other asset it is not always easy to identify, as it is all relative. However, as stated earlier we know for a fact that the total supply in my example, ETHUSD, is always going to be capped. Demand on the other hand, is constantly going to be changing. One way demand can be inferred is fundamental analysis, technically if enough people were to say "to the moon" and the unspoken HODL agreement is maintained, price could rise forever as people continue to put money into the market. Another way to find demand is looking at historical price relative to historical volume, find areas where volume was low yet price still pushed higher. This occurs when enough are people are actively buying the asset but there is a majority of people intentionally holding the bag. This is a phenomenon known as a supply crunch and is exclusive to assets with capped supply. As these people continuously buy, the asset's price moves higher in search of absorption or where market participants may want to sell their holdings. As mentioned before, these can be found with time/price based volume studies that for simplicity sake I will refer to as "volume wells" (3A and 3B). More often than not these volume wells a result of ranging markets and come in different sizes depending on the longevity of the consolidation/accumulation period.
Tying it Together-
Using these three principles to breakdown markets, one can better establish an understanding of price action and envision the market as whole rather than piece by piece. Furthermore, the understanding of how buyers and seller are interacting minimizes the risk when trading. I hope this was helpful and remember, there is no right or wrong way to trade and I intend for this post to be strictly educational. Feel free to leave your thoughts or questions in the comments.
There are 3 main discussion points in this post They are numbered on the chart in order and the numbers will also be used to tie them to their principle.
1. Aggression: Who is currently more aggressive in the market? Buyer or sellers? Aggression in markets simply is the continued buying or selling at higher or lower prices respectively, causing rapid fluctuations. I try to mark the more significant areas of aggression as they often have more importance in the broader scheme of things. For ETHUSD, in 2021, we have seen tons of buyer aggression causing large breakouts, often followed by selling aggression after new highs are created. These types of moves can not be predicted, nor can we establish how long they will carry on, though after the fact they are of upmost importance. For reference, (1), (2), (4), (5), (6) are all areas of aggression I identified on this chart. To identify these I look for volume that is relatively higher than usual as this shows the increase of interaction between buyers and sellers. I then find the bias which is simple on a candle chart- red or green. Typically with larger aggressive moves there is a scenario that occurs referred to as imbalance. An imbalance is formed when buyers raise the bid or sellers lower the ask quickly creating larger fluctuations in prices. These imbalances are often POI's during a retrace.
2. Absorption: Absorption is when there is a large group of resting limit buy or sell orders that temporarily or fully halt selling or buying action. This information can be accessed in real time with level 2 data in the stock market though I'm not to sure how to identify them best real time in the cryptocurrency market as it is decentralized. Though absorption isn't dependent on aggression, it can easily be identified when there is an aggressive party in the market. First, the assumption must be made that prices with downward/upward momentum will continue in the same direction as long as the majority of the money in the market retains bull or bear bias. Theoretically, one must assume that as long as there is no worthy contest, prices will remain moving to infinity or 0. Second, the study of volume. If there is an obvious directional movement, volume is continuing to increase, and prices are unchanged as buy/sell pressure continues, then it is safe to assume that there is larger amount of limit orders than active/aggressive orders, in a nut shell that is all absorption is. Example- [ (1), (2), (6), (A), (B)(ABSP1) (ABSP2)] . What happens next is a competition of the buyers or sellers for the best possible prices and trends form in that direction until their position is fully formed, example-(COMP). Absorption areas are often referred to as support and resistance and in a consolidating market these areas are easy to identify. They often creating a mix of limit buyers/sellers along with "market" buyers/sellers resulting from the fact that both of these parties have identified these levels and they both are in agreement that it is a buy/sell zone [(6)]. If these supports and resistances are broken (typically a result of aggression) those on the sidelines may see a chance to enter the market causing aggression/breakouts, for example- (5).
3. Supply and Demand- Supply and demand is essential for understanding any market and is arguably the biggest influence on price. When it comes to understanding demand in the form of Cryptos or any other asset it is not always easy to identify, as it is all relative. However, as stated earlier we know for a fact that the total supply in my example, ETHUSD, is always going to be capped. Demand on the other hand, is constantly going to be changing. One way demand can be inferred is fundamental analysis, technically if enough people were to say "to the moon" and the unspoken HODL agreement is maintained, price could rise forever as people continue to put money into the market. Another way to find demand is looking at historical price relative to historical volume, find areas where volume was low yet price still pushed higher. This occurs when enough are people are actively buying the asset but there is a majority of people intentionally holding the bag. This is a phenomenon known as a supply crunch and is exclusive to assets with capped supply. As these people continuously buy, the asset's price moves higher in search of absorption or where market participants may want to sell their holdings. As mentioned before, these can be found with time/price based volume studies that for simplicity sake I will refer to as "volume wells" (3A and 3B). More often than not these volume wells a result of ranging markets and come in different sizes depending on the longevity of the consolidation/accumulation period.
Tying it Together-
Using these three principles to breakdown markets, one can better establish an understanding of price action and envision the market as whole rather than piece by piece. Furthermore, the understanding of how buyers and seller are interacting minimizes the risk when trading. I hope this was helpful and remember, there is no right or wrong way to trade and I intend for this post to be strictly educational. Feel free to leave your thoughts or questions in the comments.
כתב ויתור
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