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The Basics

Price Movement Causality – Not What You Might Think

I saw the following statement made on the BabyPips site:

Forex charts are nothing but a chart of human emotions, most notably fear and greed. People don’t buy and sell because the price moves, it’s actually the other way around. Price moves because people buy and sell. All you need to do is predict where a lot of people will buy or sell and you can be a profitable forex trader…

Prices and Emotion
While the movement of prices (which of course is what charts display) are influenced by human emotion, they aren’t the only driver. Straight forward supply and demand also plays a meaningful part of it. Point blank, if there’s more demand for something than supply prices are going to rise. Emotions may slow that down or accelerate that, but eventually it’s going to happen.

And supply/demand isn’t just a long-term “fundamental” thing. It can factor in the short-term as well. For example, if GE needs to hedge a EUR 2bn transaction, that’s a big chunk of supply that will come in to the market which is at least going to make rising EUR rates very unlikely in the short-term.

People Don’t Buy/Sell Because of Price Movement
Secondly, people most definitely buy and sell because of price movement. Think about what gets you into a trade. If you’re system based then you’re entries and exits are almost certainly based on price moving to a point or through a point. Not that all trading decisions are made based on price movement, but many are.

Prices Move Because of Buying and Selling
Price actually move through the lack of buyers or the lack of sellers. The way most people think about it is that prices rise (for example) because of an increase in buying. That’s not the way it works, though. It’s only part of the equation.

Prices rise because there is insufficient selling interest at a given price to offset the buying interest. The market thus must move higher to find the selling interest to match the buying interest. This can happen if there is and influx of new buying which overwhelms the selling interest (meaning all the willing sellers have sold and none are left at current prices). It can also happen if there’s a drop in selling interest. It’s a relative relationship. Prices will only move when there’s an imbalance. It doesn’t have to mean that one side rises. An imbalance could just as easily come in when on side falls more rapidly than the other – for example selling interest falls more rapidly than buying interest.

All of this is why volume analysis is so useful (and open interest in futures/options). It can tell you whether prices are moving on the basis of more interest coming in or just because selling interest has faded more quickly than buying interest.