Align your trades with the market's natural rhythm by mastering the concepts of Premium and Discount markets. These ideas help you determine whether an asset is potentially overvalued (premium) or undervalued (discount) relative to a perceived "fair value," guiding you to trade with the flow for more strategic entries and exits. This lesson explores what premium and discount states are, how to identify them using structural reference points, and how to leverage this understanding in your trading strategy.
Level 1: What Are Premium and Discount Markets?
In price action trading, the terms Premium Market and Discount Market describe the current price of an asset relative to a perceived equilibrium or fair value level. This fair value is not a single precise point but often a zone or level derived from market structure (like significant support/demand or resistance/supply zones) or dynamic indicators (like key moving averages).
- Premium Market: A market is considered to be at a "premium" when its current price is trading significantly above its perceived fair value. This often occurs when price rallies into or tests a supply zone or a key resistance area. In such a state, the asset is considered relatively "expensive." The expectation is that sellers may become more active (initiating new shorts or taking profits on longs), potentially leading to a downward price correction towards fair value.
- Discount Market: A market is considered to be at a "discount" when its current price is trading significantly below its perceived fair value. This often happens when price declines into or tests a demand zone or a key support area. In this state, the asset is considered relatively "cheap." The expectation is that buyers may become more active (initiating new longs or taking profits on shorts), potentially leading to an upward price correction towards fair value.
The core idea of trading with the flow in this context is to anticipate these corrective moves: looking for opportunities to sell in a premium market and buy in a discount market, as price tends to gravitate back towards its equilibrium over time.
Level 2: Why Premium and Discount Markets Matter
Understanding premium and discount states is crucial for several reasons:
- Identifying Value & Opportunity: It provides a framework to assess whether current prices are overextended or offer good value relative to a structural benchmark. This helps in avoiding buying at extreme highs (premium) or selling at extreme lows (discount).
- Mean Reversion Tendency: Markets often exhibit mean reversion, meaning prices tend to return to an average or fair value after significant deviations. Premium and discount zones highlight these potential reversion points. This is often driven by profit-taking by those who rode the initial move and new participants (including institutional ones) seeing an opportunity as price reaches an extreme relative to their valuation models.
- Strategic Entry & Exit Points:
- Selling at a premium (near supply/resistance) allows for potentially better entry prices for short positions, with a logical area above the zone for stop-loss placement.
- Buying at a discount (near demand/support) offers potentially better entry prices for long positions, with a logical area below the zone for stop-loss placement.
- Confluence with Other Strategies: The concept of premium/discount aligns well with other price action tools. For instance, an Order Block found within a well-defined supply zone (premium market) can offer a high-probability short setup. Similarly, an FVG being filled in a demand zone (discount market) can present a strong buy signal.
Tools like Chart Advantage can assist by identifying key structural zones and dynamic levels (like moving averages) that help in assessing whether a market is currently trading at a premium or discount.
Level 3: How to Identify Premium and Discount Markets
Identifying these market states involves comparing current price to relevant structural reference points:
(chart://course1/trading-with-the-flow-premium-vs-discount-markets/premium-market-chart)
(chart://course1/trading-with-the-flow-premium-vs-discount-markets/discount-market-chart)
- Establish Fair Value Reference Points: This is the most crucial step. "Fair value" is not a fixed number but a concept represented by:
- Significant Support and Demand Zones: Areas where price has previously found strong buying interest.
- Significant Resistance and Supply Zones: Areas where price has previously found strong selling pressure.
- Key Moving Averages: Longer-term moving averages (e.g., 50-period, 100-period, or 200-period EMA/SMA) can act as dynamic lines of fair value, especially on higher timeframes. These averages represent the mean price over a certain period.
- Consolidation Midpoints: The middle of a well-established trading range can sometimes be seen as an equilibrium point.
- Fibonacci Retracement Levels: The 50% or 61.8% retracement level of a significant prior move can often act as a perceived fair value area before a trend continues.
- It's important to note that these fair value reference points can be dynamic and shift as new market information and price action unfold.
- Assess Current Price Position:
- Premium Market: If the current price is trading significantly above your identified fair value reference points and is approaching or within a known supply zone or major resistance. Look for signs of buying exhaustion (e.g., bearish reversal candles, divergence on indicators if used).
- Discount Market: If the current price is trading significantly below your identified fair value reference points and is approaching or within a known demand zone or major support. Look for signs of selling exhaustion (e.g., bullish reversal candles).
- Evaluate Market Structure and Trend:
- In an Uptrend: A pullback into a discount area (e.g., to a previous swing low that is now support, or a demand zone that aligns with a Higher Low) can be a high-probability buying opportunity in alignment with the larger trend. Selling at a premium might be counter-trend but could be considered for short-term trades if strong resistance is met and shows signs of failing to make a new Higher High.
- In a Downtrend: A rally into a premium area (e.g., to a previous swing high that is now resistance, or a supply zone that aligns with a Lower High) can be a high-probability selling opportunity.
- In a Range: The upper boundary of the range represents a premium (sell opportunity), and the lower boundary represents a discount (buy opportunity), with the middle of the range often acting as a temporary fair value point.
- Mark Potential Zones: Visually mark these premium (potential sell) and discount (potential buy) zones on your chart. This helps in waiting for price to reach these areas of interest.
Practical Example: On a daily chart of the S&P 500 index (SPX), let's say the 50-day EMA is currently at 4,200. A known strong demand zone exists between 4,100-4,150, and a supply zone is identified at 4,300-4,350.
- If SPX price drops to 4,120, it's in a discount market (below the 50 EMA and within demand).
- If SPX rallies to 4,330, it's in a premium market (above the 50 EMA and within supply).
Tip: Higher timeframes (4H, Daily) often define more reliable premium and discount zones due to stronger institutional footprints at these levels.
Trading Strategies with Premium and Discount Markets
Once you've assessed the market state:
- Entry Points:
- Sell in Premium: Look for short entries when price is in a premium zone (e.g., testing a supply zone or significant resistance) and shows signs of rejection (bearish candlestick patterns, failure to break higher).
- Buy in Discount: Look for long entries when price is in a discount zone (e.g., testing a demand zone or significant support) and shows signs of support holding (bullish candlestick patterns, rejection of lower prices).
- Stop Loss Placement:
- When selling in a premium zone: Place stop-loss above the high of the zone/resistance.
- When buying in a discount zone: Place stop-loss below the low of the zone/support.
- Take Profit Targets:
- A primary target is often the "fair value" reference point (e.g., the moving average price was far from).
- Alternatively, target the opposing zone (e.g., if buying in discount, target a premium/supply zone).
- Ensure a favorable Risk-Reward Ratio (e.g., at least 1:2).
- Confluence is Key: Combine this concept with other analysis:
- An FVG within a discount/demand zone can be a powerful buy signal.
- An Order Block at the edge of a premium/supply zone can be a strong sell signal.
- CHoCH/BOS confirming a reversal away from a premium/discount zone.
Practical Example: On a 4-hour chart of EUR/USD, the 200-period EMA is at 1.0800 (fair value). A supply zone is identified at 1.0900-1.0920. Price rallies to 1.0910 (premium) and forms a bearish pin bar. A short entry at 1.0905, SL at 1.0930 (25 pips risk), targeting 1.0800 (105 pips reward) offers a >1:4 RRR.
Common Mistakes
- Misjudging "Fair Value": Using insignificant levels or MAs as fair value references. The chosen reference must have demonstrated historical relevance and be appropriate for the trading timeframe.
- Ignoring the Dominant Trend: Selling in a premium during a very strong uptrend (or buying at a discount in a strong downtrend) without clear, multi-faceted signs of reversal can be risky. Premium/discount concepts are often powerful for identifying pullback entries within an established trend or for reversals from major structural extremes.
- Not Waiting for Confirmation: Entering simply because price touches a pre-defined premium/discount zone without waiting for confirming price action (like candlestick patterns or a structural shift on a lower timeframe) can lead to premature entries.
Chart Advantage: Enhancing Market Flow Analysis
Chart Advantage can assist in identifying premium and discount scenarios:
- Dynamic Level Identification: Highlighting key dynamic support/resistance levels (like MAs) that can serve as fair value references.
- Zone Detection: Automatically plotting significant supply and demand zones.
- Confluence Spotting: Potentially flagging when price enters a premium/discount zone that also aligns with other signals (e.g., FVG, Order Block), helping to identify higher probability setups.
Application & Practice: Identify and Trade Premium vs. Discount Markets
Pro Tip: While the concepts of premium and discount apply across all timeframes, they are often most effectively used in conjunction with higher timeframe trends. For example, in a strong higher timeframe uptrend, focus on buying opportunities from discount zones, as these entries align with the broader directional bias.
To apply your understanding of premium and discount markets in price action trading, try this exercise:
- Task: Select a financial instrument (stock, forex pair, or cryptocurrency) and open its chart on a platform like TradingView. Use a 1-hour or 4-hour timeframe to analyze price action over the past 1-2 months.
- Objective: Identify a fair value reference point (e.g., a key moving average like the 50-period EMA, or the midpoint of a consolidation range). Mark premium zones (near supply/resistance above fair value) and discount zones (near demand/support below fair value). Find at least one instance where price moved into a premium zone and reversed, and one where it moved into a discount zone and bounced. Define hypothetical trade entries (sell in premium, buy in discount), stop-loss, and take-profit levels for a minimum 1:2 risk-reward ratio.
- Reflection: Note the context of each zone. Did price show reversal signals (e.g., candlestick patterns) in premium/discount areas? Was the fair value reference point respected as a target for mean reversion? How did trend direction influence the outcome? Write down your observations to build confidence in trading with the market's natural flow.
- Bonus: If you have access to Chart Advantage, analyze the same chart to see how the AI identifies premium and discount zones based on supply/demand and dynamic levels. Compare its automated detection with your manual analysis to understand how AI can enhance your ability to spot high-probability trade opportunities aligned with market equilibrium.
This hands-on practice will help solidify your ability to identify and trade premium and discount market conditions for strategic entries and exits.
This hands-on practice will help solidify your ability to identify and trade premium and discount market conditions for strategic entries and exits.
Conclusion: Aligning with the Market’s Natural Flow
Understanding when a market is trading at a premium or discount relative to a sensible fair value benchmark is a powerful way to "trade with the flow." It encourages buying undervalued assets and selling overvalued ones, based on the market's tendency to seek equilibrium. This concept, when combined with solid structural analysis and confirmation signals, can significantly improve trade selection and timing.
Next Steps: In the next lesson, we will explore High-Probability Entries: BOS/Retest, Flip Zones & FVG Strategies, which will build upon the concepts of market flow and structure.