The Three Types of Market Structure for Trading

A trend is when prices consistently move in one direction. In a bullish trend, prices form higher highs and higher lows, signalling an uptrend. Alternatively, in a bearish trend, prices create lower highs and lower lows, indicating a downtrend.

When prices lack a clear direction and move sideways, this is known as a range. In this case, the highs and lows stay relatively equal.

Sometimes, a trend weakens when the price breaks its usual structure, such as a bullish trend forming a lower high. This weakness may hint at a reversal or a move into a range.

Here’s a simple approach to help you identify whether a market is trending, moving sideways, or showing signs of structural weakness:

Trending Markets: Bullish and Bearish Trends

Bullish Trends

A bullish trend is essentially an upward-moving market. Think of it as a staircase where each step (or wave) goes higher than the last. In technical terms, a bullish trend is defined by higher highs and higher lows. Each new peak (high) is above the previous one, and each valley (low) is also higher than the previous one.

Bearish Trends

On the flip side, a bearish trend is a downward-moving market, like a descending staircase. This structure features lower highs and lower lows, where each peak fails to reach the height of the previous one, and each low dips even further than the last.

Sideways Markets

But what happens when there’s no clear staircase up or down? That’s where sideways markets come into play. Also referred to as ranges, these markets lack consistent higher highs and higher lows (as in a bullish trend) or lower highs and lower lows (as in a bearish trend).

Instead, the highs and lows hover around similar areas. Imagine a mountain range in the distance – the peaks and valleys aren’t identical, but there’s no dominant upward or downward trend. In trading, ranges represent a period of indecision or equilibrium in the market.

Sideways markets often emerge when traders or investors are waiting for new information or a significant catalyst. While they may lack direction, they can still offer trading opportunities for those looking to capitalise on price moving within the range.

Weakness in the Structure

Even within a trend, there are moments when the market starts to show cracks – this is referred to as weakness in the structure. For example:

• In a bullish trend, weakness might appear as a lower high or a lower low.

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• In a bearish trend, weakness could show up as a higher low or a higher high.

Does this mean the trend is over? Not necessarily. However, it does indicate a growing likelihood of change. Weakness in the structure signals that the current trend may be losing momentum, increasing the odds of either a reversal or a transition into a sideways market.

Structural weakness is a signal that might prompt you to:

• Reassess your trade position. For example, you might choose to reduce risk by closing part of your trade.
  
  
• Delay entering a new trade. If the market’s direction is uncertain, staying on the sidelines could be the best move.

Even if the trend reverses, it doesn’t necessarily mean the new trend is going to continue. At this point, we rely on additional analysis or tools to confirm whether the reversal marks a genuine shift or just temporary market noise.

Takeaway

Understanding trends, ranges, and structural weaknesses allows us to read the market logically rather than relying on guesswork. This helps us to make decisions, and manage risk effectively. Remember, these are tools in your arsenal, not magic formulas, but they’re powerful when used wisely.