The Complete Guide to the Smart Money Concept: Mastering the Ultimate Liquidity Sweep Trading Strategy

Understanding Liquidity: A Key Component of Successful Trading

Hey Traders and welcome to another episode of Smart Risk! In this episode, we will dive deep into one of the most critical aspects of successful trading: liquidity. Whether you’re a novice trader or an experienced professional, understanding and mastering liquidity is essential for consistent profitability in the financial markets. Join us as we explore the significance of liquidity zones and how they can act as key confluence factors in our trading decisions. We’ll uncover the power of liquidity sweeps and how they can provide valuable insights into market movements, giving you the upper hand in your trading strategies. So, traders, if that’s something you’re interested in, please give this video a thumbs up to show your support and subscribe to our channel if you are new. See you after the intro!

What is Liquidity?

Liquidity simply means money or large counter orders that must be fulfilled. The market continually seeks to absorb this liquidity to generate momentum. Essentially, liquidity serves as the lifeblood of the market, playing a vital role in its overall dynamics and functioning.

Where Can Liquidity Be Found in the Market?

Liquidity can be found in various areas on the price chart. These areas, where significant volumes of orders are present, can provide insights into market dynamics and help prevent substantial losses. Some examples of liquidity zones on the price chart include:

1. Equal Lows and Swing Lows: Liquidity can often be found below previous equal lows or swing lows as these levels may attract buying interest and result in an accumulation of orders.

2. Equal Highs and Swing Highs: Liquidity can be observed above equal highs or swing highs where selling pressure may accumulate.

3. Dynamic Trend Lines and Channels: Liquidity zones can be identified above or below dynamic trend line and channel boundaries because retail traders may place orders in these areas.

4. Order Blocks and Order Flows: Areas where significant orders have been executed or pending orders are clustered can act as liquidity zones.

5. Support and Resistance Levels: Price levels that have previously acted as support or resistance often attract market participants, making them potential liquidity areas.

6. Daily Candle’s Body and Shadow: Liquidity can be present near the body or shadow of daily candles as these areas reflect price rejections and trading activity.

7. Session Highs and Lows: High and low points of trading sessions can represent liquidity zones due to increased trading activity and participant involvement.

8. Fibonacci Levels: Traders often look for liquidity around key Fibonacci retracement or extension levels as these levels are commonly monitored and traded.

Real Chart Examples

Let’s switch to the real chart and see some examples of liquidity on the price chart. On the screen, we have the four-hour timeframe price chart of the Euro/Dollar. If we look at the left side of the chart, we can notice breaks of structures to the upside. We can easily identify the order flows and order blocks, and it is evident that the market did not respect the upper order flows and order blocks. Instead, the price dropped sharply and swept the liquidity resting below these zones by triggering the stop losses of traders who had entered the market at these levels. After taking sufficient liquidity, the price used the upper zones as inducement levels and also reversed from the extreme order block, then moved sharply to the upside.

In the following example, we can see that the price has formed an internal consolidation. It is clear that the price has formed a small trend line within this consolidation. Moreover, we can spot equal lows at the bottom of the structure, creating a perfect zone of liquidity at both the top and bottom of the structure. This zone is formed by several pending buy or sell orders and modified stop-loss orders. It is crucial to always remember the significance of liquidity zones and price action. The market tends to gravitate towards these zones, and neglecting them can lead to substantial losses. Personally, I never enter a trade without identifying a liquidity sweep pattern. For example, as mentioned earlier, the reason for the price reversal from the extreme order block is the liquidity being swept below the upper order blocks and recent consolidation zone. The price gathers momentum by sweeping liquidity and gains the necessary fuel to move upwards. Here we can see how the price swept the liquidity below the equal lows with this large red candle and, after reaching the order block, it reversed and made a sharp upward move to sweep the buy-side liquidity. It is crucial to identify and consider liquidity sweep patterns before entering the market.

Next, on the chart, we can spot this strong zone that has acted as both support and resistance. This zone has generated significant liquidity above it. If we move our attention a bit lower, we can identify this bearish channel. Liquidity has accumulated both above and below this channel. As you can see, the price, after reaching this order block formed by the change in character, waved sharply move to the upside, sweeping the liquidity above the channel and triggering the stop losses of traders who had entered sell positions. Subsequently, the price continued to move upwards, sweeping the liquidity above the zone. After showing a tiny retracement, it pushed upside and swept the liquidity above this swing high.

Utilizing Liquidity Zones to Set Up Trades

Now let’s see how we can effectively utilize liquidity zones to set up trades in the market. Before we proceed to analyze real price charts and see real trading examples, let’s take a moment to understand the theory behind liquidity. This will help us establish a solid understanding of how price movement occurs in the market.

To illustrate this concept, let’s suppose we have a structure that simulates price movement. As you can see, we have an uptrend where the price has broken structures to the upside. To set up a trade, it is important to first identify the underlying trend, which in this case is bullish. Next, we look for a valid break of structure to the upside. Once a new swing high is formed, we anticipate a price pullback towards this specific point of interest to fill the inefficiency left behind.

Before entering the trade, it is crucial to spot a liquidity sweep pattern that occurs before the price reaches our point of interest. This pattern indicates the absorption of liquidity and provides an opportunity to confirm the strength of the demand in our identified area. As mentioned earlier, we use liquidity sweeps as a confluence factor before entering a position. The underlying theory is that the market requires liquidity to sustain its movement. If the price fails to sweep liquidity before reaching a point of interest, there is a high probability that price will utilize that zone as liquidity to fuel its momentum, and it’s not safe to trade in this specific case.

In the subsequent example, we have a consolidation or accumulation phase with equal lows. Our objective is to see the price sweeping the internal liquidity that has accumulated below these equal lows. This liquidity zone is formed by the stop losses of traders who entered the market with long positions, believing that the price’s pullback was over. Since the price couldn’t make a new lower low and lost its downside momentum, these traders entered long positions. Once we have received confirmation through the liquidity sweep, our next step is to see the price entering a higher timeframe demand zone. As the price action is pulled into this higher timeframe point of interest, we shift our focus to the lower timeframe within the higher timeframe POI zone. We look for a change of character in the lower timeframe. Additionally, we identify a new point of interest on the lower timeframe. Once these conditions are met, we consider going long with our target set at the external liquidity, which in this case corresponds to the swing high.

In the following example, we can see that price after reaching our point of interest and mitigating it reversed to the upside, leaving a significant inefficiency behind. It also created an internal high accompanied by a small pullback, followed by a sharp upward move that resulted in a break of structure. As a result, we now have another break of structure to the upside and a demand zone associated with the break of structure, which has the potential to reverse the price.

It is worth noting that there is another unmitigated zone near the break of structure, which can confuse traders as to which zone to trade. As we have discussed in previous episodes, inducement areas are created by large financial institutions and smart money traders like central banks. They are designed to deceive retail traders into taking buy or sell positions in the market, ultimately creating more liquidity for them. So, it’s essential to be aware of these areas and understand their potential impact on the market. For more detailed information on inducement zones, we have an exclusive video on our YouTube channel, which we will link in the description.

In this example, the order block represents an inducement level. Price artificially attempted to create a structure that would lead traders to believe that the price was about to change direction to the downside. This induced traders to enter the market by opening sell positions and placing their stop losses above the internal high. However, contrary to expectations, the price swiftly moved to the upside, breaking the recent structure. This resulted in the formation of a fake demand zone and order block.

In the subsequent example, we can see price moving downwards and reaching the inducement zone. Additionally, a small pullback to the upside is formed, which is attributed to the buying pressure of traders who entered the market with long positions from this zone. This minor pullback further induces more price action traders to enter the market by going long and placing their stop losses below the inducement zone. This collective activity creates a well-defined liquidity zone positioned just below the inducement zone, awaiting the market to sweep it. Traders who have placed their stop losses within this liquidity zone are providing a potential fuel source for the market’s momentum. Indeed, the price successfully swept the liquidity behind the inducement zone, confirming the anticipated confluence.

Our next step is to monitor the price as it enters the higher timeframe demand zone. Once the price action is pulled into the higher timeframe point of interest, we shift our focus to the lower timeframe within the higher timeframe POI zone. We search for a change of character in the lower timeframe. Additionally, we identify a new point of interest. In this case, a demand zone on the lower timeframe. When these conditions align, we consider a long opportunity with our target set at the external liquidity, which serves as the take profit level.

Now that we have a general understanding of how liquidity zones can be utilized in our trading plan to enhance profitability, let’s move into real chart examples by examining actual trades on the charts. We can gain practical insights into the application of liquidity zones in our trading decisions.

Real Chart Trade Examples

Before diving into the real chart, it’s important to note a crucial step in your trading journey: backtesting your strategies. Before applying any strategy to your real account, it’s recommended that you backtest it at least 100 times. This is because a strategy’s win rate is dependent on various factors such as market conditions, trader psychology, trading sessions, risk management, and time frame. To help you with this critical step, we use the Trader Edge platform for backtesting our exclusive trading strategies. If you’re interested in using Trader Edge as your backtesting tool, be sure to check out the link in the description below.

Let’s take a look at some real chart trade examples. Here we have the Pound/Yen 15-minute timeframe chart where we can see the following price action. As you can see, the price is in a downtrend and has created a series of BOS patterns to the downside. We can see that price, after mitigation of the previous order block, sharply declined and formed a break of structure with two large red candles, leaving behind a significant inefficiency. So, we can highlight this order block based on our analysis. We anticipate that the price will reach this point to fill the inefficiency created by the previous price action. Then, the price may reverse from this zone and resume its downward movement.

In the subsequent price movement, we can see that the price retraced back up and formed equal highs below our identified point of interest. Additionally, there is a notable liquidity pool that has formed above these equal highs, indicating a significant accumulation of pending buy orders and stop losses that are awaiting execution by the market. The presence of this liquidity pool below our identified supply zones increases the probability of a potential price reversal from our identified point of interest. Traders who have placed their buy orders in this liquidity pool are providing a potential fuel source for the market’s downward momentum.

As previously discussed, liquidity sweeps serve as a confluence factor in our trading strategy. At this point, we will patiently wait for the price to sweep the liquidity above the equal highs and enter our identified order block. Now we can see that the price has successfully swept the liquidity above equal highs and has now reached our point of interest. So, we have the desired confluence that we were seeking in our analysis. We can now consider entering a position based on this confluence and our analysis of the market.

In the next step, we will zoom in on the one-minute timeframe to obtain a clearer view of the price action and search for any signs of a change in character. Here we have the one-minute timeframe chart. As you can see, price created a major change of character by breaking this structure to the downside and also left an incredible inefficiency behind. So, in the next step, I’m going to highlight the order block generated by the chock’s wave. Also, we can easily spot this VSR pattern here, which shows a strong rejection from the higher timeframe supply zone. That means this zone would provide a higher probability if we use it to take any short position. So, guys, we have another confirmation for the entry.

Now that we have identified our point of interest, the next step is to place a sell limit order at that level. We will adjust our stop loss a few pips above the highest point of the zone to manage our risk effectively. Our target for this trade is set at the 15-minute swing low as we anticipate that price will move in that direction. Once our sell limit order is triggered, we are officially in the market.

At this point, it is important to closely monitor the price action and how the trade unfolds. As anticipated, the price started to move downwards after our sell limit order was activated, eventually reaching our take profit target. This trade provided a favorable reward to risk ratio of 1:5, reflecting a successful outcome. It’s important to note that each trade outcome may vary, and careful risk management and adherence to your trading plan are crucial for long-term success.

Now let’s go ahead and see another real chart trading example. Here we have the one-hour timeframe of the Pound/Yen chart. We can see that the price is in an uptrend and has formed these bullish BOS patterns. Within this context, we can identify two potential demand areas where the price could potentially reverse and continue its bullish trend. However, the key question is: how can we determine which of these zones is safer to trade and more likely to be respected by price?

As we discussed earlier, we only consider a zone as valid for trading if a liquidity sweep pattern has occurred below or above it. In this case, I will not consider this decisional order block as my point of interest because the price did not sweep any liquidity before reaching it. Instead, I view it as an inducement area that provides a liquidity pool below it in the market. By focusing on zones with liquidity sweep patterns, we can increase the probability of trading setups that align with market dynamics and reduce the risk of falling into false signals or traps.

In the following example, we can see that the price experienced a significant downward movement after reaching a new higher high. This was accompanied by a large red candle indicating strong selling pressure and leaving behind a great inefficiency in the market. Furthermore, there is a substantial liquidity pool that is formed below the equal lows and inducement demand zone, suggesting the presence of pending orders and stop losses waiting to be triggered and swept by the market. The presence of the liquidity pool above our identified demand zone provides additional confirmation for a potential price reversal from our point of interest.

Now that we have the desired confluence, our next step is to patiently wait for the price to sweep the liquidity below the equal lows and inducement area. Once price enters our extreme order block zone, we can consider entering a trade. Now we can see that the price has successfully swept the liquidity pool below the equal lows and inducement area and has now reached our point of interest. This confirms the desired confluence we were seeking in our analysis.

Based on this confluence and our analysis of the market, we can now consider entering a position. In the next step, let’s zoom in on the five-minute timeframe to gain a clearer view of the price action and look for any signs of a change in character. Here on the five-minute timeframe chart, we can spot a change of character as the price broke the structure to the upside, leaving behind an inefficiency. This signifies a potential shift in momentum. Additionally, we can identify the order block generated by the chock’s wave, highlighting a significant point of interest. Furthermore, we notice the presence of this VSR pattern, indicating a strong rejection from the higher timeframe’s demand zone. This pattern adds further confirmation to our entry decision, suggesting that this zone presents a higher probability for a long position.

With these confluences aligning, we have increased confidence in our trade setup. Now that we have identified our point of interest and have a clear entry signal, we can proceed to place a buy order at the highlighted level. It is essential to adjust our stop loss a few pips below the lowest point of the zone to ensure proper risk management. As for our take profit target, we are aiming for the recent major one-hour structure as it presents a significant level where we expect price to potentially reach. By setting our entry, stop loss, and take profit levels, we have established a well-defined trading plan for this setup. Now we must monitor the market closely and let the trade unfold according to our analysis.

Our buy order has been activated, and we are officially in the market. As predicted, the price rose back up after the buy order was triggered and eventually hit our take profit target. This trade provided a reward to risk ratio of 1:8, highlighting a successful outcome. Remember that trading is not just about making profits but also about managing risks and being disciplined. It takes time and practice to become a successful trader, so don’t get discouraged by losses and always keep learning and improving your skills. Keep up the good work, and I wish you all the best in your trading journey.

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Frequently Asked Questions

1. What is liquidity in trading?

Liquidity in trading refers to the availability of money or large counter orders that need to be fulfilled. It is the lifeblood of the market and plays a vital role in its overall dynamics and functioning.

2. How can I identify liquidity zones on the price chart?

Liquidity zones can be identified in various areas on the price chart. Some common examples include equal lows and swing lows, equal highs and swing highs, dynamic trend lines and channels, order blocks and order flows, support and resistance levels, daily candle’s body and shadow, session highs and lows, and Fibonacci levels. These areas often attract significant volumes of orders and can provide insights into market dynamics.

3. Why are liquidity sweeps important in trading?

Liquidity sweeps serve as a confluence factor in trading strategies. They indicate the absorption of liquidity and provide an opportunity to confirm the strength of the demand or supply in a specific area. By considering liquidity sweeps before entering a position, traders can increase the probability of successful trades and reduce the risk of false signals or traps.

4. How can I utilize liquidity zones to set up trades?

To utilize liquidity zones in setting up trades, it is important to first identify the underlying trend and look for valid breaks of structure. Once a point of interest is identified, traders should wait for a liquidity sweep pattern to occur before entering a position. This pattern confirms the absorption of liquidity and provides a confluence factor for the trade setup. By monitoring the price action and looking for signs of a change in character, traders can further enhance their entry decisions.

5. What is the importance of risk management in trading?

Risk management is crucial in trading to protect capital and ensure long-term profitability. It involves setting appropriate stop loss levels, managing position sizes, and adhering to a trading plan. By effectively managing risk, traders can limit potential losses and preserve their trading capital, increasing the chances of success in the long run.