In the today's article, we will discuss an important term in Smart Money Concepts trading - the liquidity sweep.
I will teach you what is liquidity sweep, explain how it relates to liquidity zones and imbalance, and share a lot of real market examples.
The understanding of a liquidity sweep is essential for the correct interpretation of the market behavior and the actions of the institutional and retail traders. And a consequence, this knowledge will help you to properly apply SMC trading strategy.
To grasp the concept of liquidity sweep, you should learn 2 crucial things:
You should learn to perceive the price chart as a pool of buy and sell orders - the liquidity, on different price levels.
And you should understand how the institutional traders act.
1. The Liquidity
The distribution of trading orders on the market is not equal. While some price levels lack the orders, some areas or levels have dense cluster of orders. We call such areas the liquidity zones.
Historically significant key levels and support/resistance areas represent important liquidity zones from Smart Money Concepts perspective.
Structure resistances accumulate selling orders as the market participants anticipate bearish reactions from such areas, and buyers apply them as the targets - closing their long trades there(selling them).
These zones also can be called supply zones
Above is the example of a liquidity zone on GBPCAD. It is a historically significant resistance and we assume that selling orders concentrate there.
Structure supports accumulate buying orders as the market participants anticipate bullish reactions to such areas, and sellers apply them as the targets - closing their shorts trades there(buying them).
These zones also can be called demand zones
Above is the example of a liquidity zone that potentially concentrate a pull of buying orders, because its historical significance.
As the market participants place their orders within the liquidity zones, they also set stop losses. Stop losses represent certain levels on a price chart where the active trading positions will be closed in a loss.
Stop losses of the retail traders is the main aim of smart money.
But we will discuss it later on.
Selling from a key structure resistance area, sellers usually set their stop loss orders above that.
Take a look how stop losses of retail traders are placed above the liquidity zone.
While buying from a key support, stop losses of the buyers are lying below that.
Above you can see where concentration of stop losses below the liquidity zone that we discussed earlier.
When a stop loss of a long position is reached, it automatically converts that position to a market order to sell. Long position is sold to the market.
Bearish movement below the liquidity zone would trigger stop losses of buyers.
When a stop loss of a short position is reached, it converts that trade to a market order to buy. The trader is buying back the asset that one previously sold short - Short position is bought by the market.
A bullish continuation above the liquidity zone on GBPCAD would make sellers close their trades on stop loss.
When the market participants place a lot of orders in one area, it creates a pool of market orders, their stop losses lie very close to each other as well.
When the price reaches the levels of these stop losses, it triggers the opening of a huge amount of orders.
The institutional traders aware the exact positioning of the orders of the market participants and their stop losses.
2. Institutional Traders
Big players, the banks, the hedge funds trade with huge trading volumes. However, in comparison to retail traders, Smart money do not trade with one single order.
Instead, they apply the order fragmentation - the strategy of institutional traders of splitting their large orders into smaller orders to minimize market impact.
To hide their presence and to avoid the slippage of the market, they need liquidity.
With price manipulations, they induce retail traders to open the trading positions in the opposite direction, or they make them close their positions in loss, providing the so much need liquidity.
Now, imagine that big players need to buy a huge volume of orders from a certain significant support cluster.
To obtain the needed liquidity, they can manipulate the price to make it move down and stop out the buyers.
Take a look at that significant liquidity zone. Its bearish violation will make many traders close their positions in loss - sell their positions.
As the buying orders will be closed on stop losses, they will be sold to the market.
This event will provide the liquidity for Smart Money and they will absorb/buy all these orders, clearing out available liquidity at various price levels where stop losses are hit.
Such a phenomenon will be called a liquidity sweep.
Above is a perfect example of a liquidity sweep. Smart Money absorbed the needed liquidity and the market quickly reversed and went up, revealing the real intention of big players.
A similar situation happens when Smart Money need to sell a huge volume of orders from a certain resistance.
To obtain the needed liquidity, they can manipulate the price to make it move up and stop out the sellers.
Look how the price violated a massive liquidity zone on GBPAUD. It made retail traders close their short position in loss.
As the selling orders will be closed on stop losses, the sellers will be automatically buying back the asset that they previously sold short.
This event will provide the liquidity for Smart Money, and with liquidity sweep they will absorb all these orders, clearing out available liquidity at various price levels where stop losses are hit.
That is one more example of a liquidity sweep, where Smart Money absorbed all buying orders and then pushed the prices down.
Quite often such a price manipulation is very quick,
For that reason, a very common characteristic of a liquidity sweep is a formation of a single candlestick with a long wick above/below a liquidity zone.
Usually, after a valid liquidity sweep, the market tends to form an imbalance candle, indicating real intentions of Smart Money.
Above, we see a false violation of a liquidity zone with a long wick that was followed by a bullish imbalance - perfect example of a liquidity sweep.
Of course, there are various other examples of a liquidity sweep.
However, the situations that we discussed are the most common.
The understanding of Liquidity Sweep is crucial for a correct application of Smart Money Concepts trading strategy. It is one of the key events that you should look for trading entries and that helps to correctly interpret the actions of Smart Money.
