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Understanding Liquidity and Market Pullbacks
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Understanding Liquidity and Market Pullbacks

  #11 (permalink)
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josh View Post
No, buy limit orders cannot be above the current market. A buy stop can be, or a buy stop limit, but neither are examples of resting liquidity. A buy limit says "buy at this price or lower" -- a buy limit placed above the market would be immediately filled as a marketable order, since the current inside offer would be a lower price than the limit price.

Thank you for your post Josh, I now "get" what was being said there.

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  #12 (permalink)
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An eye Opener, but ...

thanks for this article and the analogy, DT. i enjoyed reading it, twice .. an eye opener for a bignner like me.. now have homework to research more about the topic .. but...

digesting this, doesn't this mean that again, "price action reflects everything", or that "all conditions are built-into the Price Action", lack of supply, demand, liquidity (providers/consumers), buyers uptake, sellers, news....etc. yes, in some cases, you may need to wait for few more candles to confirm if a move is a knee-jerk reaction to some news or a sustainable one, but again, it's all reflected "in the price action" itself? is that a correct statement from your expereince? cause in that case, a bigenner can then focus only on price action and related analysis and still be good to go?

thanks,
RedK

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  #13 (permalink)
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Where can I find the "cumulative delta" indicator you have in the picture?



DionysusToast View Post
Nature abhors a vacuum

If you want to understand why the market pulls back in an uptrend, keep "Nature abhors a vacuum" in mind.

- An uptrend starts.
- Price is at 1245
- There is ZERO buy side liquidity above 1245
- There IS buy side liquidity below 1245
- There IS sell side liquidity above 1245
- Market buy orders 'eat' the sell side liquidity and break through the ceiling
- Price moves up and up and up
- We are now at 1250
- There was no buy side liquidity above 1245 before
- There will be SOME buy side liquidity between 1245 and 1250 but it will be NEW liquidity that got placed there as price moved up.
- Some of this new buy side liquidity will be Market Makers who were SELLING as the market moved up
- Other people will have submitted new buy side liquidity on the way up
- Other people will still be THINKING about submitting buy side liquidity

The area between 1245->1250 now has (to an extent) a 'liquidity vacuum' on the buy side. The liquidity hasn't had chance to build up in that area as it has on the sell side. We are at 1250 - we have moved up into an area where sell side liquidity has been sitting for a while. We moved up into an area where no buy side liquidity existed before but where sell side liquidity exists. The ceiling is strong and the floor is very weak. Any uptrend will have a mix of market buyers and market sellers eating liquidity on both sides. We have market buyers and sellers, we have a strong ceiling and we have a weak floor.

- The market starts to move down as the weak floor is consumed on relatively little market selling
- Some new sellers may be thinking 'reversal' and jump on short
- As we move down, we move 'further back' in time OR to prices that have been traded a while back and where there has been more time to consider a buy side limit order
- We move down and the floor gets a little thicker
- At the same time, we move down into an area with ZERO sell side liquidity, the vacuum is now being created above us.

Eventually, we get to a point where we have a thicker floor below us and a relatively thin ceiling above. Price starts to move up and a whole bunch of traders (like me) think "Continuation". Anyone that sold the pullback starts to feel a little queasy and pukes out (by buying); we may see a little acceleration to the upside as the market becomes quite one-sided. Then the process starts over again.

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The above picture shows price and cumulative delta.

We can see here a typical intra-day move. The top chart shows the price and the bottom chart shows the cumulative delta. Price moves down about 14 points with 2 major pullbacks. You can see that as the market is pulling back up, the cumulative delta hardly moves up at all (relative to the down move). We can safely say that this up move was caused by lack of sell side liquidity as a 'vacuum' was created there by the down move. It didn't take many buy market orders to move the price back up to where the liquidity was.

This is where we have the confidence to sell into a move up because we know that the move is caused by a temporary lack of sell side liquidity.

In Summary

The market is like a hi-rise building. It has floors (buy limit orders) and ceilings (sell limit orders).

It takes market orders to eat these floors & ceilings.

As you move up and go through a ceiling, it takes time to rebuild the floor behind you.

This lack of a floor, or 'liquidity vacuum' is the cause of pullbacks in trends.

This represents opportunity for you. Once you know that the market is 'vacuuming back', you suddenly aren't scared of fading that pullback.


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  #14 (permalink)
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TrendTraderBH View Post
Where can I find the "cumulative delta" indicator you have in the picture?

GomRecorder, includes GomCD:
https://futures.io/elite-circle/6802-gomrecorder-2-a.html

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  #15 (permalink)
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DionysusToast View Post
I agree Josh - it all comes down to interpretation and context.

In the example, the expectation is that the market is likely to continue. We have a fairly new intraday down move initiated in which a fair amount of people participated. Chances are it'll continue for at least another push down. It's not an area where lots of people will have their fingers on the button waiting to take a trade, so less open to gameplay. The presumption that it is vacuuming back up is therefore a safer one in this case. It is just a presumption though.


I don't use this at prior highs because when you get to a prior high, you almost always see a lot more sell side liquidity that buy side (although whether it's fake or not is a different matter). You also tend to see a lot more people trying to play these areas which means larger players nudge it around to take advantage of them.

Great posts, thanks. But CD can move up as market comes down, meaning limit sell orders (waiting for bounces as we go down) easily absorbing market buy orders. But the point that limit sell orders can only be above in terms of liquidity is well made.

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  #16 (permalink)
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I like your post on Sellers liquidity above the Ask and Buyers liquidity below the Bid - makes logical sense. I really do agree with what you have presented as it explains what I see. But you got me thinking too...

I came across this other site's scenario I have burned into my memory. Market moves are caused by large players and if you have to ask who is a large player, surrender to the fact you are not one. If a big player decides it’s time to trade, they do so. They do what they want, when they want – period. And if no other big player is against them, there’s a very high likely hood the market will do what they want. But if two of these players butt heads; one sees long, the other sees short, their egos kick into gear big time and crazy things happen. In either case, we little guys are out there trying to apply “logic” to their ego driven, anything but logical reasons.

It’s a known fact that humans like patterns. This may be simplistic, but look at the clouds on any given cloudy day and tell me what you see. We look for things. We look at graphs of digital data and say it moved to within a tic or two of that that prior tic - wow that's significant. Well of course it moved like it did, it’s measured in tics, it’s digital data. Look at peg board – can you draw lines through the dots – of course you can. We look for this because it helps us explain what is before us. We like to be able to succinctly define why something did what it did. Have you ever tried to define why your teenage kid did what they did?

Please don’t take me wrong, I really do agree with your presented logic of buyer and seller liquidity, but have you ever seen a chart where logic was perfectly illustrated, yet price did the complete opposite? We then say, well nothing always works, the best you get is x%, it's a numbers game.

I have come to consider I am trying to apply logic where logic does not apply. I am drawing/seeing lines becuase it's easy to do so being digital data. I have come to accept the closest thing to logic rules of the market are un-measureable, that being greed and fear. And here I go seemingly contradicting myself, consider the setup that was absolutely perfect yet it failed - I present the reason why is because of the un logical, un measureable market metric of greed and fear, the egos of head butting big players causing crazy things to happen. Why, because they can, it's what they/we do. It's what makes the market move.

I am reminded of the movie Pirates of the Caribbean, the rules are sort of guidelines.

There is no mathematically ridged, algebraic, calculus based, differential equation; no physics or economics based logic rule set that defines the market - otherwise it would have been automated by now.

It's more like the big penguin that jumps off of an iceberg and “busts” a move for all the other penguins. Why, becuase he wanted to eat some fish.

This does not mean trading is impossible. I believe successful trading is accomplished by taking advantage of momentum(not the indicator), of price action, of a sense of feel of the market - which you acquire over time. It’s like the “touch” required when fly fishing, the “instinct” of a talented athlete, the “presence” of a truly great leader. You cannot measure these things, which at times seem to defy logic. Yet you and I know them when we experience them.

Again, I really do like you most excellent post...


Last edited by tulanch; August 22nd, 2012 at 08:44 PM.
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  #17 (permalink)
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I guess I'm going to be the naysayer

Although I get the semantical concept, liquidity (or lackthereof) doesn't move the market, buying and selling move the market. A lack of liquidity will allow the market to move further and faster, but make no mistake, without someone there to buy or sell, all the dead space in the world isn't going to move the price.

This is akin to explaining to people that there's no such thing as "cold" energy. There's only energy, which migrates from higher concentrations to lower concentrations. When you cool something off, you simply drive the energy (against it's natural state) to an area of higher concentration (which takes energy to do so).

The same is true for the concept of a "vacuum." Vacuums don't "suck" material into them, they simply create a space of lower concentration and when exposed to higher concentrations, particles migrate and push themselves into the void. Even the process of creating a vacuum requires you to "push" the particles in the space somewhere else.

Semantics yes, I know...but liquidity doesn't "draw" price into lower areas, there still has to be buying/selling in order to move the market.

I guess a more precise way to describe it is that under "normal" or sterile circumstances, the concentration of buying and selling determines which way price moves. More sellers than buyers and price drops. And vice versa.

But in the case of "pullbacks" the recent market movement has removed much of the market depth as you pointed out, so a lesser disparity of buying/selling is required to move the market back through the void created.

I guess what I'm saying is that if price is at xx.xx and there's absolutely no market depth above it, that alone will not move price higher, there actually has to be physical orders (buy) in order to move it.

But I like the way you laid out and explained the groundwork as to how/why pullbacks happen, which also will help us to better understand how to identify and hopefully predict when they're likely.

"A dumb man never learns. A smart man learns from his own failure and success. But a wise man learns from the failure and success of others."
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  #18 (permalink)
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RM99 View Post
I guess I'm going to be the naysayer

Although I get the semantical concept, liquidity (or lackthereof) doesn't move the market, buying and selling move the market. A lack of liquidity will allow the market to move further and faster, but make no mistake, without someone there to buy or sell, all the dead space in the world isn't going to move the price.

This is akin to explaining to people that there's no such thing as "cold" energy. There's only energy, which migrates from higher concentrations to lower concentrations. When you cool something off, you simply drive the energy (against it's natural state) to an area of higher concentration (which takes energy to do so).

The same is true for the concept of a "vacuum." Vacuums don't "suck" material into them, they simply create a space of lower concentration and when exposed to higher concentrations, particles migrate and push themselves into the void. Even the process of creating a vacuum requires you to "push" the particles in the space somewhere else.

Semantics yes, I know...but liquidity doesn't "draw" price into lower areas, there still has to be buying/selling in order to move the market.

I guess a more precise way to describe it is that under "normal" or sterile circumstances, the concentration of buying and selling determines which way price moves. More sellers than buyers and price drops. And vice versa.

But in the case of "pullbacks" the recent market movement has removed much of the market depth as you pointed out, so a lesser disparity of buying/selling is required to move the market back through the void created.

I guess what I'm saying is that if price is at xx.xx and there's absolutely no market depth above it, that alone will not move price higher, there actually has to be physical orders (buy) in order to move it.

But I like the way you laid out and explained the groundwork as to how/why pullbacks happen, which also will help us to better understand how to identify and hopefully predict when they're likely.

I agree with your premise, but I think DT did not mean to imply that the vacuum itself moves prices, but that the relative lack of liquidity (the vacuum) makes it easier for a lesser amount of pressure for marketable orders to move price a greater distance than otherwise would be the case.

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  #19 (permalink)
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josh View Post
I agree with your premise, but I think DT did not mean to imply that the vacuum itself moves prices, but that the relative lack of liquidity (the vacuum) makes it easier for a lesser amount of pressure for marketable orders to move price a greater distance than otherwise would be the case.

Exactly correct.

It's also the same concept that creates breakouts...when price stagnates, buyers and sellers, producers and consumers become impatient and the market depth begins to encroach and creep closer to the price, which creates a higher barrier to overcome, but once the barrier is breached, the relative depth behind it is less and so price tends to move relatively ununcumbered until the market can catch up to it and re-establish a more normal depth surrounding it.

"A dumb man never learns. A smart man learns from his own failure and success. But a wise man learns from the failure and success of others."
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  #20 (permalink)
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josh View Post
I agree with your premise, but I think DT did not mean to imply that the vacuum itself moves prices, but that the relative lack of liquidity (the vacuum) makes it easier for a lesser amount of pressure for marketable orders to move price a greater distance than otherwise would be the case.

Indeed!

There is ALWAYS buying & selling going on - but as you get less and less liquidity below, it can no longer support a small amount of selling.

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