Somebody asked me recently:
“Why do forex price runs always seem to fizzle out, and then reverse just as savagely as they started?”
It’s a great question, and one of the ways I like to explain this phenomenon is by using the concept of Entropy. Entropy forex trading is essentially the art of capturing moves when price momentum stalls and reverses. What is Entropy?
I guess we can start off with a couple of definitions from the Internet. The first of the following refers to entropy as it relates to the laws of physics. The second definition gives a hint of how entropy enters into market economics:
- Physics: a thermodynamic quantity representing the unavailability of a system’s thermal energy for conversion into mechanical work, often interpreted as the degree of disorder or randomness in the system. “the second law of thermodynamics says that entropy always increases with time”
- General: a lack of order or predictability; gradual decline into disorder. “a marketplace where entropy reigns supreme”
So, how is this related to forex trading, and more particularly, how can we use it to make money?
We have all seen skyrockets shoot into the sky, and then either explode in a brilliant display, or just “top out” at the end of their run, flip over and begin a rapidly accelerating retracement of their path.
The same dynamics can be seen at work in political, artistic and cultural movements (e.g. the cultural revolutions of the 1960s).Entropy Forex Trading is the art of capturing moves when price momentum stalls and reverses.Click To Tweet
The fact is, due to the inbuilt laws of the universe, anything that starts out with a burst of energy and expands rapidly, will encounter increasing resistance, combined with growing levels of ‘wastage’ that slow things down. This will see the original momentum slow, stop and then reverse.
What do I mean by wastage? It refers to the way that a rapid growth period results in “waste products” that become a drain on the original energy of the movement. Eventually, this drain represents a force equal to the original momentum, and things come to a stop.
The same thing can be observed in forex price spikes. Understanding the mechanics of forex price spikes – combined with a predictive indicator like the Paleo indicator that plots likely levels of reaction and resistance ahead of time – gives us the edge we need to get in early when price begins to reverse.Understanding Entropy in forex price spikes enables us to get in at the start of price moves…Click To Tweet
Here are a couple of old posts on AuthenticFX relating to the mechanics of forex price spikes:
These posts are a little outdated now, and their information has been greatly expanded on and updated in the Price Action Engine course. If you’re not familiar with this course, I heartily recommend you check it out. People often ask me about the Price Action Engine, and I usually tell them the following:
“The Price Action Engine is an education in the real drivers behind price movement, plus what I have found to be the very best tools – especially the Paleo indicator – to trade according to that knowledge. Aside from the Paleo indicator, there are several other bonus indicators and tools that I have found to be useful, and use in my own trading.
It is not a trading strategy with strict rules for entry, exit etc., nor is it intended to be a Holy Grail system.
Together – the knowledge and the tools – make up the toolbox that is the Price Action Engine. That toolbox is meant to enable traders to either design their own strategies and systems, or to use any other strategy that appeals to them and which they believe to be reasonably sensible, in a profitable manner. It is certainly the toolbox that I use in my own trading, and I am happy to recommend it to other traders.”
Again, I recommend you check it out:
Understanding the actual inner dynamics and mechanics of price movement is fundamental to success in price action trading. After many years of trying everything under the sun to become a successful trader, I can tell you that the only thing that really works – whether you incorporate it into manual or automated trading – is Price Action trading.
And if price action is the most important thing in trading, understanding the concept of Entropy in forex trading of price spikes is probably one of the most powerful insights you will ever gain.
As ever, I welcome your thoughts and feedback in the comments section below.
Take Care & Trade Well,