Liquidity is a fundamental concept in trading and investing, but for newcomers, it can sound a bit abstract. In simple terms, liquidity is the availability of buyers and sellers in the market, which makes it easy to buy or sell an asset without significantly affecting its price. Think of it like a bustling marketplace where there are always people ready to buy or sell; that’s a liquid market. But there’s more to liquidity,In trading than most people would consider it to be. These are not my concepts. These are concepts we learned from ICT.
According to ICT, an algorithm controls the price and the aim of the algorithm is to match the orders of buyers and sellers. So if there are a lot of orders at one point, then the algorithm might seek to go there to get those orders. In this way the algorithm matches the orders of both buyers and sellers. Now if we ask the question- Where would these orders be? Then the logical answer would be mostly below old lows and highs. Let us illustrate this by an example.
Supposing a person took a short on USDJPY on top left, then he would put his stop loss above the highs. So his order will be above the high. And as the market dropped, he may choose to move his stop loss order above an old high to scale his position. Now there may be other market players with a bullish view on USDJPY and they may be breakout traders and they would put a buy limit order above the high. The reverse is true of an old low. The low here on the right hand side will have stopout orders of traders who may have entered long anywhere along the big green candle. And similarly market players who may have a bearish view on USDJPY and are breakout traders will have sell limit orders below the low. So as you can see there is plenty of liquidity( resting orders) above an old low or high.
Then there is another type of liquidity that the algorithm seeks to deliver. These are the fair value gaps. Here is a simple illustration of a fair value gap. The fair value gap is the body of the candle where the wicks do not overlap. This can also be called an imbalance.
This is the nasdaq daily chart and it illustrates the imbalance. When price has moved like this where there have been a lot of buy orders above, then at some point price returns to these areas to offer fair value to buyers according to ICT. But in our view, this is another form of liquidity as if you look at the lower time frames you will see lows and highs on the lower timeframe that may have buy and sell orders. We will use the same nasdaq chart on a lower timeframe to illustrate this.
As you can see from the chart, we have lower timeframe lows which could be targets for the algorithm to match orders.
So in conclusion, we can say that the algorithm delivering the price will seek liquidity to match orders. The liquidity runs that it performs will be either above an old high or old low or into an FVG.
According to ICT, there are two types of liquidity. One is external liquidity. This is the liquidity residing above the lows and highs of a range. Again using the USDJPY chart, for the current range the external liquidity will be resting above the high here and the low here. The internal range liquidity is the FVG that are found in the range.
Price goes from internal range liquidity to external range liquidity and the price goes from external range liquidity to internal range liquidity.
Why Does Liquidity Matter in Trading?
Liquidity is essential because it tells us where price is likely to go. Traders use liquidity zones (FVG) to anticipate where the market might move, creating an opportunity to enter or exit trades at optimal points. Let’s say price is moving up, and there’s a significant old high level above; traders may expect the price to reach that level to "sweep" the liquidity resting there before reversing. By understanding where the algorithm delivering the price would go,traders can better predict potential market moves, setting themselves up for higher-probability trades.
Furthermore, big players often target liquidity areas because they need significant volumes to fulfil their large orders without causing unfavourable price movements. For a big player, buying or selling isn’t as simple as clicking a button. They need to enter or exit positions strategically, so they seek out liquidity pools (like FVGs or old highs/lows) to avoid sudden spikes or dips in price.
Framing trades using liquidity concepts:
Framing trades in a trending market:
Here the market is in an established trend. As we have said above the price goes from internal liquidity to external liquidity and from the external liquidity to internal liquidity. Let's look at a recent chart of the Dow Jones. This is the Dow Jones 1 hour chart.
Here the price is in a bullish trend. The price is making higher lows and higher highs and in other words the algorithm is delivering from internal range liquidity to external range liquidity. If we zoom in and add the FVG, then it will become more obvious.
Here first price breaks out with displacement to form a bullish trend. The price then retraces into an FVG/internal range liquidity before making a bullish move to take out the old high. The price remains in a bullish trend until the market structure is broken. So in a bullish trend, we look for entries in the FVG and target the external range liquidity above. We can also say that in a bullish trend the FVG’s act as support.
Here is the Dow Jones chart after the market structure is broken and is in a bearish trend.
So once a low is broken with displacement, then we have a market structure shift and the algorithm will now seek liquidity below. So retracements to an FVG is a sell targeting the external range liquidity. We can expect the algorithm to continue delivering this until the market structure is broken to the upside.
Framing trades in a ranging market:
This is the weekly chart of the Dollar index. Here the price has been in broad consolidation for many weeks. If we look closely we can see how the liquidity has been targeted by the algorithm as shown in the figure below.
There are three phases of the market. Consolidation, expansion and retracement. Trading a market which is in consolidation can be very difficult as traders can get chopped around. And so the traders should only get involved in the top and bottom of the ranges.
To summarise:
The price delivery is controlled by an algorithm that aims to match the orders of buyers and sellers
The orders mostly reside below the highs and lows of any given range.
Inorder to match the orders, the algorithm will aim to go to these old highs and lows.
In a trending market, the price is delivered from internal range liquidity(FVG) to external liquidity(high or low)
In a consolidating market, the price is delivered from one side of the market to the other.
How to use Liquidity in framing trades:
Now that we know the basic concepts of liquidity, let us look at how we can use this knowledge to frame trades. Here we present a few strategies.
STRATEGY 1- Entering after raid of Asian range liquidity
For the sake of simplicity, the asian range can be defined as 10pm UK time to 7Am UK time. Usually there is not much activity and most of the markets go into consolidation apart from asian indices and asian currencies. As the market goes into consolidation, liquidity builds up on both sides of the consolidation. According to ICT, this consolidation should be tight - the particular market should not be trending overnight. As liquidity builds up, this becomes the target for the algorithm.
In a bullish market, we enter after a raid of the asian session lows and market structure break with stops below the low.
This is the Dow Jones industrial average and the chart shows the price delivery of a bullish swing. The shaded areas are the asian ranges. The price is raided before the price expands to the upside. It is important to remember that this pattern is not always there. But if it presents itself it will give us a great entry near the lows of the day with defined risk. There should be some kind of lower timeframe market structure shift before the entry and the stop will be below that swing low that formed the shift in market structure. To illustrate further let’s review the price action of the first shaded area.
This is the 5 min chart of the same chart of dow jones. The shaded area is the Asian range During the london session there is a raid of the liquidity residing below the asian range. This will also induce a bearish sentiment to induce traders to short. However on the higher timeframe the price is bullish. So we will look for longs. As soon as the market structure is broken, the longs can be taken with stops below the lows.
In a bearish market, we enter after the asian range liquidity above has been raided.
This is the dow jones 1 hour chart showing price delivery of a bearish swing. The shaded area is the asian range. Here at the start of the London session, the market makes a false move down before taking the liquidity of the Asian range and price then goes lower in the New York session.
STRATEGY 2- Entering after raid of a daily low or high
Daily lows and highs have large pools of liquidity and so the algorithm targets these all the time. These will give us very good entry points to target the opposing liquidity pool.
In a bullish trend, we enter after a raid of the daily low followed by lower timeframe market structure shift.
This is the weekly chart of the dax. Here there was consolidation followed by a stop run before a bullish move. We will study the price action on the daily chart.
Here I have marked the areas where the liquidity runs happened. And everytime this happens there is a strong move upwards.
Entering trades to target liquidity pools:
If price is in a bullish trend and there is a liquidity pool above the trend, then we can frame trades in the lower timeframe to target the liquidity pool. And if price is in a bearish trend, and there is a liquidity pool below, then we can frame trades to target these. Here is an illustration of this in the USDJPY weekly chart.
The USDJPY pair had a big move down and once a swing low was taken at the top, we look for internal range liquidity in the form of swinglows withing the range and fair value gaps. We have marked the liquidity here.So once we have the swing low broken, we can frame trades to target internal range liquidity pools and finally taking out a monthly low where there will be big orders. As you can see immediately after the liquidity was taken, the price started to move higher. Once it restarts its original trend, we now look for longs to target internal range liquidity within the down swing. This is the FVG that we have marked on the chart. So longs can be taken at lower timeframes to target the FVG.
In the future we will post more videos with examples of how we used liquidity to frame trades and give examples of the 3 strategies that we have outlined above.
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