Dive into the world of trading, and you're bound to come across the intriguing concept of liquidity. Far from just a buzzword whispered by financial gurus, liquidity is a core market force that shapes the ebbs and flows of assets like Forex and stocks. Join us as we embark on a fascinating journey to demystify the world of liquidity and uncover the powerful role it plays in trading success.

Defining Liquidity in Trading

So let's first talk about the definition of liquidity. Liquidity refers to the availability of orders at specific price points in the market, allowing transactions to occur smoothly. When traders discuss liquidity, they typically refer to the resting orders in the market, which can be absorbed or targeted by banks or financial institutions (BFIs) to manipulate price action patterns. Liquidity is everywhere in the market, some spots more then others and it is possible to learn how to spot it.
‍

Liquidity as Resting Orders in the Market

To visualize liquidity, think of it as the collection of orders that accumulate in the market, such as limit orders, stop loss orders, and stop limit orders. These orders are activated when price interacts with particular supply or demand levels in the market. Liquidity is crucial in understanding price movement.

‍

Understand that for every buyer, there must be a seller, and vice versa, to maintain a balanced market. Simply picture a shopkeeper unable to sell their products without interested buyers - a similar principle applies to liquidity in trading.

Why is liquidity so important to understand?

Liquidity can help you to determine where the price is likely to head next. In conjunction with higher timeframe market structure, supply and demand, and order flow, liquidity can give you insights into potential price movement. It's essential to practice using liquidity alongside trend analysis and supply and demand to read market conditions effectively.

Contrary to popular belief, liquidity is vital for market movement. Highly liquid markets, such as Forex, indices, commodities, stock, and crypto markets, are often manipulated by large banks, institutions, or "whales" that can control the market by absorbing buy or sell orders. This manipulation can lead to liquidity shortages, causing price slippage and poor trade execution. Below you can see an example of a liquidity pool getting grabbed, where price afterwards takes up with lot of momentum to the upside. You can recognize the liquidity pool of the slow sideways moving price action (range/ consolidation).

‍

Types of liquidity

1. Structural Liquidity

Structural liquidity refers to the liquidity found at significant price pivots or structure points that are responsible for breaking one or more levels of structure. When there is a clear level where the price pivots, buyer's stop losses accumulate below the pivot demand level, while seller's stop losses build up above the pivot supply level. Understanding structural liquidity involves recognizing its dual nature:

Liquidity Traps: In some cases, structural liquidity can be swept or grabbed to create a liquidity trap, assisting banks or financial institutions (BFIs) in establishing or offloading their market positions. By luring in traders with the promise of a break in the trend or structure, BFIs can manipulate price action and capitalize on the resulting movement.

Fuel for Price Movement: Alternatively, structural liquidity can be targeted by BFIs to drive prices in a specific direction. By manipulating the market and profiting from built positions, BFIs can exploit structural liquidity to their advantage, shaping market trends and influencing price action.

The free Sonarlab Liquidity finder will help you spot structural liquidity.

2. Buy Side Liquidity (BSL)

Buy side liquidity is any accumulation of orders situated above a range or high, where seller's stop losses (buy orders) and breakout trader's orders (buy stop limits) are poised to be executed. These orders can be targeted by BFIs to fuel a momentary or sustained bullish price movement. Buy side liquidity serves two essential purposes in the market:

Targeting Highs: Highs in the market can be seen as potential buy side liquidity (BSL) areas. BFIs often target these highs, utilizing the accumulated orders to drive the price upward.

Focusing on Lows: In some cases, targeted lows can also be classified as buy side liquidity. These lows can serve as potential entry points for traders looking to capitalize on the bullish momentum.

The free Sonarlab Liquidity finder will help you spot structural liquidity.

3. Sell Side Liquidity (SSL)

Sell side liquidity is the accumulation of orders located below a range or low, where buyer's stop losses (sell orders) and breakout trader's orders (sell stop limits) are ready to be executed. Like buy side liquidity, sell side liquidity can be targeted by BFIs to fuel a momentary or sustained bearish price movement. Sell side liquidity plays a critical role in two market scenarios:

Targeting Lows: Lows in the market can be seen as potential sell side liquidity (SSL) areas. BFIs can target these lows, utilizing the accumulated orders to drive the price downward.

Focusing on Highs: Alternatively, targeted highs can also be classified as sell side liquidity. These highs can serve as potential entry points for traders looking to capitalize on the bearish momentum.

The free Sonarlab Liquidity finder will help you spot structural liquidity.

‍

‍