How I saved my day with liquidity pools

Instrument : DAX CFD

Date : 27.07.2021 14h46 (UTC+2)

Again I will take the opportunity of a trade I took yesterday from the DAX cfd to explain some trading concepts that could be useful to you. And this time, it’s a pretty bad trade that could have resulted in a big loss. I closed it with a small profit by being confident in my overall analysis from liquidity pools, and I will explain how I did it.

Here is a my (pretty usual) trading P/L curve from yesterday. You can see that there is something not linear there, this is due to the trade I will explain in a moment. I opened several positions, and I had to close some of these in loss to lower my risk. This trade resulted in a very small gain overall (when all positions were closed) but some of the positions were closed in loss and some others in profit.

Here is the chart showing my analysis and the red zone where I entered some sell positions:

  1. It’s always interesting to note that the overnight trend induced some sellers because you will often see a reverse from this overnight trend after london open to grab the liquidity from overnight traders.
  2. london open induced some more sellers by creating a new obvious down trend line + a violent 130 points selling move
  3. Notice the buyers reaction at 15420 and 15440. The first one is not a small reaction, and the second one did not break the previous low: we can guess selling activity is over for now.
  4. Price is making some new higher highs and creating a new obvious buying trend line. Also it broke the previous down trend line + previous high at 15530, inducing some buyers.
  5. Then I saw price consolidating around 15530 zone and real time price moves was showing some weakness from buyers: all mini moves higher were quickly rejected during almost an hour. This is where I entered some sells position to bet on this obvious up trend line and the fact that people were most likely buying this since a few hours.
    And the volatility from this day let me think that the selling activity was not over yet.
  6. Price kept going up and my sell positions were in drawdown. My mental stop loss was around 15600, it means I was about to close it when I saw these 2 big red candles at the top forming an interesting M pattern that I explained in some older articles.
    Then the price broke the up trend line and my target to close the positions was very precise and clear for me: the liquidity pool around 15520. Let’s see why.

Why would the algos hit the liquidity zones

I hope it’s not a surprise for you anymore that the algos are seeking for liquidity because they need to take your money. In this business, someone is loosing money when you win some, and someone is winning money when you loose some. The banks and hedge funds are using algorithms programmed to induce sellers or buyers and then take their money.

There are two main ways to do this:

  1. by hitting your stop losses orders
  2. by trapping traders in a direction and moving the price in the other direction (most traders will be forced to close in loss at one point because the drawdown will be too big or their account will be at 0)

Actually you loose some money with spreads and commissions too, but that’s not the topic of this article.

How do we know there is a liquidity zone below 15520?

We don’t need some magic indicators to know where liquidity pools are. We know that traders are learned to put their stop losses orders below previous lows and above previous highs to secure their position.
This mass behavior is the basis of what we call “stop runs” or “stop hunt”: these are violent moves below a low point or above a high point to trigger all the stop loss orders.

There was obviously a lot of stop losses in the zone below 15520 because:

  1. The violent reversal at the low of the day induced some buyers
  2. The new up trend was quite obvious
  3. The previous down trend line has been broken at 15500 inducing a lot of buyers
  4. If you wanted to buy, the consolidation right after this break let the time to enter a position and 15520 was the low of the consolidation zone. It means all buyers during and after this consolidation will most likely put their stop loss below 15520 because it became: a low point on the trendline + a low from a ranging zone

As usual, I hope you’ll learn something from this article. The outcome of the trade here is not the most important, the thinking process and analysis is much more important.

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