Price Action Study - Liquidity Pools

CME_MINI:NQ1!   NASDAQ 100 E-mini Futures
As retail traders, we have the luxury of entering and exiting any position with ease - the size of our trades are not large enough to affect the market whatsoever.
Now put yourself in the shoes of a bank, a multi-billion dollar fund - any type of institutional trader. You want to go long $2 billion dollars on a stock, a forex pair, a cryptocurrency - in doing so you face some issues.

  • You're trading massive size. These types of orders are nearly impossible to hide - people reading the tape, watching level 2 or the DOM (Depth of market, footprint, etc) will see your order from a mile away and front-run you so they can get in on the coming volatility .
  • Remember - for every buyer (you) there needs to be a seller. How can you ensure you can receive $2bil in shares at the price you're looking for? Who's providing that liquidity?
  • Following up on point 1 - you can't just buy, buy, buy 100 lots at a time until you get the quantity you desire - price will have moved substantially by the time you're done.

So what are you to do? Take advantage of liquidity pools!

Here's the premise:
  • Short selling provides long liquidity - they sell the stock anticipating price will go down.
  • Longs provide short liquidity - they buy the stock anticipating price will go up.

As an institutional trader, what do you need in order to go long?
Many peoples selling short.

What do you need in order to go short?
Trapped buyers.

So this brings us to the next question - How do institutions create sellers if they want to go long, how do they create buyers if they want to go short?

Liquidity Pools
Liquidity pools are areas where we can assume clusters of limit orders and/or stops reside.
Pending limit orders are, by definition - liquidity! They are triggered as price trades through a particular area.

From an institutional perspective - if price trades through X:
  • Buy orders hit the market = potential short liquidity.
  • Sell orders hit the market = potential long liquidity.

This brings us to the next question: How do institutions identify liquidity pools?
The answer: Where does the average retail trader place their stop?
  • Below a swing low or a range low (think flags, channels, trends)
  • Above a swing high or a range high (think flags, channels, trends)

Above highs, retail traders wait to buy the breakout. They create short liquidity by buying from institutions who are selling short, with the intention of taking the price lower.
Retail traders who short tops tend to place stops right above them - their buy stops create short liquidity as well if price is to wick through a high before going lower.

Trading breakouts, breakdowns and ranges from this perspective gives much more context to "fake breakouts" as they were - the key takeaway is to avoid placing your stops in obvious areas - as these regions tend to get hunted for liquidity.

-Will, OptionsSwing Analyst


Thanks for sharing your work on liquidity pools. This chart and published idea has been featured in Editors' Picks,
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+24 Reply
Interesting article. I agree with the concept of stop hunts by large institutional traders, but I have always questioned the notion that retail, lonely, private and self-employed traders are the main targets of institutional traders. The volume of money placed on the market, ie, the risk value, by lonely, private, mostly self-employed retail traders, even collectively, does not scratch a nudge on the $5B+ traded every day on the FX market by institutional traders. The battle between buyers and sellers in the FX or even any financial market, is the battle between institutional traders. If this looks like true, then retail, self-employed traders are like those small animals in the jungle who benefit from and live off the spoils and remains (carcasses) of the fight between the big animals ("warlords") of the jungle. Technical analysis and price action are the best tools with which the retail trader may have some bite off of the vanquished institutional trader during the battle between the titans of the jungle. In my opinion, what is termed liquidity pool doesn't look worlds apart from what some retail traders refer to as support and resistance and what others refer to by different names. In the long run, I have discovered that every trading system which is a product of well reasoned market observation of repeated market patterns and which aligns with the personality, psychology and risk tolerance of the retail trader is profitable for him/her at the end.
+54 Reply
@ajviral this made so much sense. it put exactly what I've had in mind into words
+4 Reply
ajviral fixin280
@fixin280, Thanks
KingJon216 ajviral
@ajviral, Exactly.. Whenever lionesses are chasing down their prey, hyenas and vultures are close by, at a safe distance, waiting to feast on what they leave. That should be our mentality. The forex market was designed to let currency be exchanged easier, and later to let corporations offset a contract or future purchase that they plan to make. It was later that large investors decided to try and profit from exchange rate differentials. Support/resistance, supply/demand zones, whatever you want to call them are the areas where large investors and central banks battle. Successful retailers sit by at a safe distance and let them battle it out, then swoop in quickly to eat….
+9 Reply
ajviral KingJon216
@KingJon216, On point
@ajviral, 👏👏👏👏
+1 Reply
ajviral elevatedinvestor
@ajviral, Exactly, I have been saying the same thing for years in chat rooms here for the longest time. And of course I get scolded and ridiculed all the time by amateurs there because I don't believe in some kind of conspiracy that institutions are out to screw the "little retail trader". I have been trading successfully for over 28 years and never once have I ever worried about these so called liquidity pools. They look like nothing more than support and resistance levels to me and that is how I approach them. Of course when you place trades around support and resistance levels there are always going to be orders on the books that are little bit higher or lower. That is just traders trying to do the same thing you are doing and trying to get a better price. They may be successful or they may not. In my book they are called bottom and top pickers. And in my experience that is a low percent hit ratio type of trade and that is why I only trade momentum into an existing trend. That guarantees me a much higher hit ratio and is much easier to trade mentally and I don't get "whipsawed" no where near as much as the top and bottom pickers. Momentum is always on my side is the reason why. The trend is your friend. My motto is buy high and sell higher and sell short low and buy to cover lower all withing the existing trend. Try it you may be surprised at the results.
+30 Reply