Module 2: Core SMC - Market Structure
You'll Learn: How to accurately identify trends, reversals (ChoCH), and continuations (BOS) using institutional market structure principles, and differentiate between internal and external structure.
Understanding Market Structure in SMC
Market structure is the backbone of all price action. In traditional retail trading, it's often simplified to higher highs/higher lows for uptrends and lower lows/lower highs for downtrends. While true, SMC takes this a step further by focusing on the validity of these swings based on liquidity sweeps and institutional order flow.
Understanding market structure allows you to identify the prevailing trend, anticipate potential reversals, and find high-probability areas for entry and exit. It's about seeing the "story" the market is telling through its price movements, particularly how "Smart Money" is accumulating or distributing.
Think of it like reading a building's blueprints: You need to understand the foundational elements before you can build on top of them. Market structure is your blueprint for the market.
Break of Structure (BOS): Trend Continuation
A Break of Structure (BOS) signifies the continuation of the current trend. It occurs when price unequivocally breaks and closes beyond a significant swing high (in an uptrend) or swing low (in a downtrend), indicating that the dominant order flow is still in control.
For a valid BOS:
In an uptrend, price must break above the previous Higher High (HH).
In a downtrend, price must break below the previous Lower Low (LL).
The break should ideally be with a strong, impulsive candle close (body closure preferred, not just a wick). This indicates conviction from institutional players.
BOS Example (Uptrend):
Imagine price making a HH, then pulling back to a Higher Low (HL), and then pushing up to create a new HH, clearly surpassing the previous HH. This move confirms the uptrend's continuation and is marked as a BOS.
*(In a real lesson, you would include an image/chart example here to illustrate BOS.)*
Not every breach of a swing high/low is a valid BOS. Look for clear body closures and impulsive moves. Wicks that just 'touch' can often be liquidity grabs, not true structure breaks.
Change of Character (ChoCH): Trend Reversal
A Change of Character (ChoCH) is the first signal of a potential trend reversal. It occurs when price breaks the most recent significant swing low in an uptrend, or the most recent significant swing high in a downtrend. This suggests a shift in the underlying order flow and institutional sentiment.
For a valid ChoCH:
In an uptrend, price must break below the most recent valid Higher Low (HL) that initiated the last Higher High.
In a downtrend, price must break above the most recent valid Lower High (LH) that initiated the last Lower Low.
Similar to BOS, look for a clear, impulsive candle close beyond the structural point.
ChoCH Example (Uptrend to Downtrend):
Price has been making HHs and HLs. It makes a new HH, then instead of pulling back and making another HL, it breaks below the previous valid HL. This break is your ChoCH, signaling a potential shift from bullish to bearish sentiment.
*(Again, an image/chart example would be crucial here.)*
A ChoCH is an early indication of a reversal, not a confirmation of a new trend. It often serves as a warning sign to adjust your bias or look for bearish setups after a bullish trend (and vice versa).
Internal vs. External Structure
To truly master market structure, you must differentiate between Internal (Minor) Structure and External (Major) Structure.
External (Major) Structure
This refers to the main, overall trend on the current timeframe. It's defined by the significant swing highs and swing lows that are responsible for the major directional moves. A BOS or ChoCH on external structure carries more weight and signifies a bigger shift.
- Represents the dominant trend.
- Breaks indicate significant continuation or reversal.
- Often seen on higher timeframes (e.g., Daily, 4-hour).
Internal (Minor) Structure
This refers to the pullbacks and smaller movements within the larger external leg. Price often makes multiple BOS (internal) as it retraces or moves impulsively within one major leg. These internal breaks help identify smaller, trading opportunities or confirmation for entries on lower timeframes.
- Movements within a major trend leg.
- Can provide short-term trading opportunities.
- Often seen on lower timeframes (e.g., 1-hour, 15-minute).
The Zoom-In Analogy:
Imagine looking at a mountain range (External Structure). You see the big peaks and valleys. Now, zoom in to one of those valleys (Internal Structure). You'll see smaller hills and dips within that larger valley. Both are important for navigating, but the mountain range gives you the overall direction.
Confusing internal with external structure is a common mistake. Always identify your major (external) structural points first, and then look for internal movements within those major swings.
Identifying Valid Swing Points
Not every high or low is a valid swing point for determining market structure. A valid swing high or low must:
- Be a clear point where price reversed.
- Preferably have taken out liquidity from a previous swing point (this will be covered in later modules, but keep it in mind).
- Initiate a move that breaks previous internal structure (for internal swings) or external structure (for external swings).
Practice is key here. As you analyze charts, you'll develop an eye for what constitutes a significant, valid swing point.