Stop Drawing Liquidity Lines... Use THIS Instead

If you think that this is liquidity, like a dumbass uninformed retail trader, professionals instead use charts like these to see where actual liquidity is resting. But it's not that easy. See, you have two types of liquidity, market makers and market takers. These areas of liquidity are market makers instead any buy stops or sell stop is market taker liquidity. And don't worry, banks are not hunting for your stupid stop loss. All right, today I will give you an insights on how actual professionals look at liquidity. And we will start debunking a little bit some disturbingly common misconception around the ICT space about liquidity. So ladies, buckle up and let's learn how heat maps work. Ha. By the way, this is one of a series of videos, a full course I'm making about real order flow. I'll leave you the link to the whole playlist down below. Enjoy the video. Ciao. So as you have seen from the previous videos of this course, if you didn't watch them and you know zero about order flow, you should watch them before watching this video. These, and these are sell limits. In the order book they are the offer or the ask. The lower part we have the bid which are buy limits. This is the so called passive liquidity. So limit orders that are waiting to be filled by aggressive orders by market orders. So all of this is our supply of orders in the market. The demand of orders in the market are aggressive buyers and aggressive sellers which you will see in the heat map as these bubbles. Anyway, what the heat map does is as you can see, projects the current hottest areas of liquidity. So in this half of the chart you see the current order book in a heat map graphical version. But before, before this line which is the current price, we also have the history of how this order book changed through time because as you can see, it does change quite a lot. And this is the first very important thing to remember. Most of the orders that you will see here are not going to stay there forever because this are intentional orders. This is not real market pressure. This is only an expression of the intention of buyers and sellers to eventually buy or sell at better prices. But as with your normal trading, if you put a buy limit, you are free to take it off the market because maybe you're not so sure of that buy anymore. Same thing can happen in the order book. So the areas of liquidity that you will see are not necessarily going to be there forever. Now as you probably understood, the hottest areas are the areas where there's more orders the colder the area, the less orders there are on the book. And as you can see watching the chart back in time, there is this constant black area around the current price which kind of follows the price. This is what I personally call the market maker cloud. I don't know if it has another name, but basically in every market there are some major market makers whose only business is to quote both the ask and the bid at the same time and make a gain based on pure bid ask spread. I explained this in the previous video where we talk about MBO order flow. So especially those blue areas of orders are likely going to be canceled before price actually gets there. So what we can do with most heat maps is increase or decrease the contrast in a way that we can filter out all that noise and just have on our chart the most important areas. But also as you can see, some of the hottest areas, sometime they disappear, sometimes they're canceled, and some instead don't. This area, for example, is a very hot area of liquidity. There's a lot of sell limits above here. So this is a clear supply zone. And most market participant in the professional sites are going to see the liquidity. Most retailers won't because they're not using order flow, but the professional side will. And some of these orders might actually be placed there by institution or hedge funds. And one of the first takes you want to have about these kind of zones is the thicker these areas of liquidity, the lesser the chance that the price will just go through them, but the higher the chance that price will reverse around these points, maybe get some strength, and then eventually try and hit them. Now let's go and zoom in all of this. And if you really closely take a look at this chart, you will see that there's two lines constantly moving. And these lines represent the best ask and the best bid, which respectively are the best price at which there's at least one buy limit in the order book and the best price at which there's at least one sell limit in the order book. So these are the best prices where you can be executed. So if you say buy a contract market right now, you will be executed here. If you sell market right now, you will be executed here. Now let's zoom in a little bit more and watch actual market mechanics in action. And as you can see, as soon as one of these bubbles hits the green line, that green line goes up. Because this is all aggressive orders hitting the ask, lifting the ask higher and higher, and accepting to keep buying at higher and higher prices. Exactly like inside of an auction. Which is why we have to take a little moment and talk about auction market theory. Auction market theory was born around the 70s and the 80s, and it's something that you might have heard of before. Auction market theory basically implies that market revolves around two main phases, which is phases of balance, where we have a balanced market, and phases where price goes into discovery of new prices. So in a balanced market, market participants are agreeing that this area is the best price to both buy and sell, which is also known as a fair price or a fair value. The biggest market participants, as you know, are investment banks, hedge funds, investment funds, pension funds, HFT firms, universities, endowments or college endowments, like the Yale or the Harvard hedge funds, sovereign funds. Then you have CTAs, CPOs, blah blah, blah. So the participants in the markets are not just banks who hunts for retail traders stop losses. The real war inside of the market is between big market participants and not all big money. Because this is what we define as big money, so does not equal smart money. For example, I would consider big money, but not necessarily smart money operators like pension funds or investment funds. Some investment funds can only buy as an example, so they can only be the buy side of the market. So these market participants are not necessarily going to manipulate order flow to try and get the best fill out of the market, as investment banks, hedge funds and HFT firms would maybe do, because most of these are long term participants. So if they have 2, 3, 5, $10 billion that they have to fill in a specific market, they're not going to necessarily spoof and use icebergs and manipulate order flow to get their order filled. So the physiological necessities of big participants are not the same between big participants. What we call smart money, instead, in the realm of order flow, is, let's say, trickier participants. But what all of the big money has in common is that in order to fill their orders, most likely they have to fragment their order. So the best moment for a big money participant to enter the market is when there is a fair value, when there is an agreement between the parties that buying and selling at that price is okay. These are the most liquid moments of the market where liquidity is at its highest. Because the more liquid is the market, the more counterparty there is to my trades, the more I can trade without impacting price movements and move the price a lot with my orders. Take as an example this book, which has an average of 50 contracts per level. If I have 2000 contracts to fill today, because I'm a trader in the prop desk of a bank. If I directly buy market at the best price, 2000 orders, I would move the price. Let's calculate it. 2000 orders divided by 50, it's 40 ticks which divided by 4 because it's 4 points. 4 ticks per point, it's 10 points. So with one order I would move the price from here, right over here with just with one 2000 contract order. And trust me, for the average S&P 500 order book, that's not a lot of contracts. So instead of filling a 2000 contracts order here, I'm going to have to accept worse and worse prices. And my average fill will be somewhere around here when it could have been around here. So to optimize the filling of the orders, some smart money participants are going to fragment their order into smaller and smaller orders or anyway will prefer to trade when there is liquidity, when there is agreement on the market. If I have to buy 2,000 contracts, I want someone to sell me those 2,000 contracts at that price. I would not like to get it filled this way. So the intrinsic nature of the market is areas of liquidity, of agreement, of fair value, and areas where someone is ready to accept worse and worse prices to get their fill, pushing the auction of orders higher and higher until a new area is found where there is liquidity, where there is a counterparty, where there is new balance in the market. And if I keep drawing price action, you would probably start noticing that these looks a lot like Wyckoff cycles. The only difference is that what Wyckoff coded more than 100 years ago is this face and this face and this face and this face, which are also known as accumulation, spring markup, reaccumulation, spring markup, distribution, up thrust markdown, redistribution up thrust markdown, and so on and so forth. So what Wyckoff understood 100 years ago, without having any electronic devices whatsoever, but purely drawing daily candle on pieces of paper, was what today we know as auction market theory. Now today there is a new wave of trading with which is the whole smart money concept, ICT school of trading, which also I've seen today. This is known as a power of three, which is a concept by Larry Williams where he also coded this consolidation, manipulation and expansion or distribution. They call this part distribution or the whole new wave of ICT concepts, ICT smart money concepts, which is basically consolidation, manipulation, expansion, then contraction and so on and so forth. So now they just have basically a fancier name. But in the professional side of the market, in order flow, in auction market theory, theory, these things have been known for a while since around the 70s when Dalton and Stadelmaier Coded invented the market profile, the volume profile and auction market theory as a whole. So back to our heat map. Based on the auction market theory concept, that market are looking for liquidity and for areas in which is easier to exchange contracts, we can start understanding that market is attracted to liquidity. And when I'm talking about liquidity, I'm not talking about stop losses or stop orders because they're only one side of liquidity. They are these bubbles, these bubble are stop orders. So this is one side of the market, the aggressive side of the market. But I'm also talking about these area of liquidity. So these areas of liquidity usually work as a magnet for the market. So market will be attracted to these areas. But also what a magnet does if you pose the same force is it pushes away. So sometimes big areas like this one will discourage aggressive buyers to go and buy into that level and to push the auction higher. Because if they see that there's a huge interest in selling at a price level, they will probably at least slow down or stop their run higher. Now some of these areas of liquidity, as you can see, they don't last long. But when price passes through there, you can see that those bubbles are big. Which means that aggressive orders has actually find liquidity in these areas. So some of these areas work as a magnet, as an attraction, Some of them work as a threat for current market direction. Now as we can see, while price is consolidating here, more and more liquidity starts building up up here. So there's a huge intention of sellers and also a huge intention of buyers down. But when price moves down, all of a sudden all of that goes away. For now there is one level which is staying pretty consistent, which is this one below here. As you can see in this part, these order are following price action. This is what we usually know as spoofing. So orders which are just to scare the market and make it go lower, let's see how this will end up. And let's also take into consideration that below here we have the daily low. So probably below here we're going to have some stops. So when the price goes below here, if there is a bunch of stop orders there, we will see a bunch of these pink bubble suddenly entering the market and sweeping away all the liquidity in the book. There you go. This is exactly what happened below the low we went straight to a vertical downward movement. Now if we zoom out a little bit, we will see that there's more levels of liquidity down here. Now this level of liquidity has been taken and as this was taken, more liquidity started forming around here. Let's see how that ends up. And as you can see now, price start moving higher. Now as you can see from the amount of bubbles in this area, there was a huge fight and this fight didn't happen between banks and retails. Let me tell you, price is now breaking above these highs. So now the most probable areas the price will go to is these level over here also because they seem pretty consistent through time. So usually when there is a bunch of levels like these, there's a good chance we will go through them one by one. As you can see, market went through the first level, up to the second level. Let's see if it will go also up to that level. Now as we're getting closer to the New York session, as you can see, the market starts being really, really liquid. You can easily see how the books become increasingly, increasingly hotter as the cash session starts kicking in. And this is usually where the real fun begins. But as you can see, price went exactly right through all of those liquidity areas. But now there is a big wall of both buyers and seller, both buyers and sellers. So there's no clear difference in market pressure. So in the first part of the New York session, what often happen is pure war. War between aggressive buyers, aggressive sellers, passive buyers and passive sellers. This is a fair market, this is a stake. Still a pretty balanced market as you can see both from the book and from price action. As you can see in the first part of the session, we've gone down here to try and meet this liquidity over here. Then more liquidity has formed out above here. And we pushed throughout every single one of these levels and every more level of liquidity that has formed was taken. Now if we zoom out a little bit, we will see that a bigger cluster of orders is right above here. So we will see how price will interact with that. And the first reaction as we can see is that after all of this run in liquidity, for the first time, price is aggressive. Buyers are start to be less and less active in this upper parts and some aggressive seller starts kicking in. Now if this area of liquidity after it's been taken comes back here as new sell side. So from buy side we start creating a sell side liquidity. This is what is also known as a flipping, which is technically illegal, but sometimes happen. In this case, it didn't exactly happen. Price starts getting back revisiting These highs. But new liquidity kicks in right here. If we zoom out, probably we will see that this cluster of liquidity is starting to get really, really hot. The market doesn't keep trying attacking that area. They try once more but they fail again and we go down. And at this point, as you can see, there has been a very vertical phase in the market. This is a stop run. And you might think, hey, this is a stop run. So we must have taken out some daily high or daily low. But as you can see, it's not necessarily that way. The lows of the day and of the session are right below here. But still we can see a very vertical move which completely swept away or swept away all the liquidity in the book. This, what many call liquidity run may be one big order of the one big market participant. But as in most of these cases, this imbalance created a very thin order book. So the path of least resistance for the price would be this one. Now if we zoom out again a little bit, these three areas of liquidity might as well be taken and one by one, with a little bit of breath, eventually they get taken. Now, as I said before, what happened here is a flipping. So after this liquidity has been taken and this liquidity was completely ran through and price inverted from that area, then we have a new buy side liquidity which was sell side liquidity before this is called a flipping and it's a very common inversion pattern. Now we just tapped into this area and all of the orders were consumed or taken out of the market. So there's a high chance we're going to break and move to the next liquidity zone. There you go. This type of analysis or trading is also called liquidity to liquidity. So as you can see, this is a bit of a different way to look at the market. But if you're a short term trader, this is a much more complete version of the markets. And trust me when I'm saying we are just scratching the surface now, because with MBO order flow, the one I explained in the previous video, you can basically put heat maps on steroids. So if you want to make me a video about that where I show you the MBO indicators that shows you iceberg orders and stop runs with 100% objectivity. Let's reach at least 1000 likes to this video and let me know that in the comments. All right. I hope you understood if you didn't leave a comment, I'll try to answer. And if you enjoyed this video and it opened your mind a little bit on how actual liquidity works. 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