TRADING FOUNDATION: WHY DOES PRICE MOVE (PART 1 - LIQUIDITY)WHY DOES PRICE MOVE IN THE FOREX MARKET?
A simple answer to this question is... price moves for 2 major reasons
To take liquidity
To fill imbalances or price inefficiencies
I will break this into two parts and discuss Liquidity first.
What is Liquidity in Forex Trading?
Liquidity is the presence of orders at specific prices in the market, ensuring that transactions can take place without disruptions. When traders talk about liquidity, they are usually referring to the resting orders in the market. These orders can be absorbed or targeted by banks and financial institutions (BFIs) to influence the patterns of price movement. Liquidity can be found throughout the market, although certain areas may have higher levels than others. The good news is that it is indeed possible to learn how to identify and recognize liquidity patterns.
Liquidity comprises a variety of orders that gather in the market, including limit orders, stop loss orders, and stop limit orders. These orders come into play when prices reach specific levels of supply or demand in the market. Understanding liquidity is essential in comprehending how prices move.
Why do you need to understand Liquidity?
Liquidity is crucial for predicting price movements. Analyzing liquidity, along with market structure, supply and demand, and order flow, provides insights into potential price directions. It's important to consider liquidity alongside trend analysis and supply and demand to understand market conditions effectively. Highly liquid markets can be manipulated by large banks or institutions, leading to liquidity shortages, price slippage, and poor trade execution. Recognizing liquidity pools during slow sideways price movements is key.
What are the main types of Liquidity in Forex trading?
1. Buy-side liquidity (see chart for example)
Buy-side liquidity refers to the accumulation of orders above a range or high, including buy-stop limits and stop losses placed by sellers and breakout traders. Banks and financial institutions (BFIs) may target these orders to fuel temporary or sustained bullish price movements.
Buy-side liquidity can be divided into 3
a. Relatively equal highs liquidity
b. Previous high liquidity
c. Trendline liquidity
a. Relatively equal highs: This is when the price fails to break a level within a minimum of two tries. When this happens, there is a high tendency that orders will be above that level i.e. stop-losses or buy-stop orders. Due to this, large institutions will target that level to liquidate their orders or fill new orders. see the example below.
b. Previous high: A previous high is the top of a level or range from which a retracement in price started. Every high in the market holds liquidity. Usually not as appealing at the relatively equal highs. see the example below.
c. Trendline: This liquidity setup is usually as appealing as the relatively equal highs as it provides enough liquidity in the market to liquidate orders of large funds or fill in more orders. Anytime you notice a buy-side trendline liquidity building up, expect that price will move radically fast towards it. see example below
2. Sell-side liquidity (see chart for example)
Sell-side liquidity refers to the collection of orders situated below a range or low, including sell-stop limits and stop losses placed by buyers and breakout traders. Banks and financial institutions (BFIs) can target these orders to generate temporary or sustained bearish price movements. Similar to buy-side liquidity, sell-side liquidity serves a crucial role in the market dynamics.
Sell-side liquidity can be divided into 3
a. Relatively equal lows liquidity
b. Previous low liquidity
c. Trendline liquidity
a. Relatively equal lows: This is when the price fails to break a level within a minimum of two tries. When this happens, there is a high tendency that orders will be below that level i.e. stop-losses or sell-stop orders. Due to this, large institutions will target that level to liquidate their orders or fill new orders. see the example below.
b. Previous low: A previous low is simply put at the top of a level or range from which a retracement in price started. Every low in the market holds liquidity. Usually not as appealing at the relatively equal lows. see the example below.
c. Trendline: This liquidity setup is usually as appealing as the relatively equal lows as it provides enough liquidity in the market to liquidate orders of large funds or fill in more orders. Anytime you notice a sell-side trendline liquidity building up, expect that price will move radically fast towards it. see example below
Note : This does not mean you should just trade based on where you see liquidity, you should also do a proper multi-timeframe analysis, and if your narrative aligns with where liquidity is resting, there is a higher chance for it to go there.
I will make a post on the Part 2 - Imbalances.
Ensure to follow so you see what it is and how to make good use of it.
Cheers,
Jabari
