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Understanding Liquidity and Market Pullbacks
Started:August 8th, 2012 (11:22 PM) by DionysusToast Views / Replies:11,645 / 38
Last Reply:November 3rd, 2012 (02:35 PM) Attachments:2

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Understanding Liquidity and Market Pullbacks

Old August 23rd, 2012, 08:08 PM   #31 (permalink)
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OK Mike,

Is the logic behind it is available. If yes, I could try to wrote it and publish it


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Old August 23rd, 2012, 08:15 PM   #32 (permalink)
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arjfca View Post
OK Mike,

Is the logic behind it is available. If yes, I could try to wrote it and publish it


Let's try to keep this thread on-topic. I will just very quickly say, yes the code is available, and no, you will not be able to make it work with MultiCharts based on my experience and understanding. But you can go to the right thread and check for yourself


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Old August 23rd, 2012, 08:45 PM   #33 (permalink)
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Markets tend to function well when a sufficient number of diverse investors interact (liquid markets), and they tend to become fragile when this diversity breaks down (illiquid markets). The algorithms that drive high frequency trading respond quickly to order flow and price . Quotes are revised in response to trading, and trading is done in response to changes in quotes, giving rise to a two‐way dynamic relationship between the two events. Algos can easily take into account common factor price information and adjust trading and quoting accordingly, moving away or cancelling existing bids and offers. Other algos are designed to identify order flow and other information patterns in the data and react in the same way or shut down altogether. Liquidity demanders will wait until the supply of liquidity is ample, therefore, volatility is more often a result of liquidity being pulled by suppliers e.g., the flash crash, than an increase in buying or selling that demands liquidity.

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Old August 24th, 2012, 04:28 AM   #34 (permalink)
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I watch bars on my charts tic by tic, When I see - hitting the price, hitting the price, hitting the price, (like a bobber when fishing) and price magically holds/floats, with above average trading/volume/order flow(important), - I think - is some big player watching market reaction to their efforts? If simultaneously book orders build on the other side, as the hitting continues (ie building above if holding price is resistance to a down move) and then all of a sudden the high side orders are pulled just as there is a flood of low side orders, what's a possible outcome? Demand/Supply - Demand is now high and Supply is now low (especially if pulled close to the ask). Price goes towards the pulled orders; it could go for a while or just a few tics(6E seems like 4 minimum), but it goes. I switch between graphs and dom, aids in when to know to focus on dom. And as always, market context must be conducive to the move.

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Old August 26th, 2012, 08:56 PM   #35 (permalink)
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"There are ZERO buy limit orders above the current price and there are ZERO sell limit orders below the current price".

- Dionysus Toast

Very well said. Ironically I was just thinking about this today, out for a walk checking out what's became of the local corn crops, lovely late summer jaunt, and ya, wondering about just this point, that is what it would be like to see the stops (liquidity) in the book rather than just the small subset of fake limit orders the exchange shows us, the general non-liquidity adding public... how much does the real data cost?

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Old August 26th, 2012, 09:02 PM   #36 (permalink)
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josh View Post
Sure, an order on the book can be pulled, but volume traded is volume traded, no matter who the aggressor is. Sellers at the bid are "real," just as the buyer they are matched to is just as "real," only difference is that one demanded a limit on an acceptable price, and one did not.

I agree, and this is what it comes down to IMO. It's kind of silly, IMO, to formulate hard and fast ideas about the way it's supposed to work, because it just isn't that clear cut.

And volume traded on the exchange is but a fraction of what is traded OTC. When the OTC crowd does cross the market, it's usually to suck out some liquidity...

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Old September 10th, 2012, 01:26 PM   #37 (permalink)
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When are these tools going to be avaialbel with multicharts?

DionysusToast View Post
This is an article I put on another forum. I'm reproducing it here, hoping it doesn't breach any sute guidelines.

It’s common knowledge that no market moves in one direction for an extended period without ‘pulling back’. There are many methods of analysis that try to make sense of these moves and counter-moves, these methods mostly rely on price data alone to guess the start and/or end point of a pullback. In this section, we will look at the liquidity model and how liquidity makes pullbacks inevitable. This isn’t an exercise in market theory; this knowledge will help you jump on board moves at the right time. It is not easy to sell into a rising market but if you understand the liquidity model, you will understand that at times, the market is rising because of a lack of sell side liquidity and NOT because buyers are jumping into the market.

In this section, we will look at the lowest level of the market to show liquidity; the lowest level being the order book. Do not think that the liquidity model only operates for order book scalpers. This model applies to all timeframes. The existence of liquidity is key to understanding price moves whatever timeframe you are looking at. It is merely easier to explain at the lowest level.

I am guessing that most people already know "don't trade the news". News releases cause some pretty violent movements in price. Have you ever stopped to wonder why? Point “A” on the chart below shows a typical news release.

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We can see that at 8:38am, news was released and 20,000 contracts traded. There are two other times that day where we see a large number of contracts trade in the time period – Points “B” and “C”. At those later high volume points, the number of contracts was high but the price move itself was much smaller. The range of the bar at point “A” is 7 points. That’s a 7 point move in 1 minute!

What we are seeing there is a lack of liquidity. That is what makes the news moves so large. The volume of trading itself is only part of the picture. It is liquidity or lack of liquidity that causes the big moves.

Imagine for a minute that the market is a hi-rise building. Price can rise up when the ceiling is broken and it can move down when the floor is broken. The market does have a ceiling above and a floor below. This is in the form of limit orders and this is what we refer to when we talk of "liquidity". In the market some floors/ceilings are thicker than others and some are thinner than others.

Something needs to 'eat' these ceilings for price to move up. The eater of liquidity is called a "market order". When someone submits a market order to the market it eats some liquidity and makes that floor/ceiling a little bit thinner. To trade a market you either need to provide liquidity (limit order) or consume liquidity (market order).

This is what causes price moves. You will often hear people say “price moves up when there are more buyers than sellers”. This is impossible. The markets are a mechanism for matching buyers and sellers. If there is no seller, you will not be buying anything. The markets move up because buy market orders consumed seller liquidity at a price level. The next buy market orders will eat the liquidity at a higher price. The numbers of contract brought = the number of contracts sold.

In the following image, you can see both the consumers and providers of liquidity on the order book. We can see existing Limit Orders and we can see the market orders that were filled against them.

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One of the most important things to understand about liquidity is that is that liquidity always and only exists at better prices than the current price. In other words, seller liquidity exists at higher prices than the current price. Buyer liquidity exists at lower prices than the current price.

This is common sense. If sellers wanted to sell below market price, then a trade would take place. Buyers would fall over themselves to buy at lower prices than market price because they would be able to turn an immediate profit.

Now, whilst liquidity only exists at better prices, ORDERS can exist at worse prices. This is not liquidity; for example a breakout trader might have a buy stop order to enter the market above the high. This is an order to enter at a worse price than current but this is going to consume liquidity, not provide it. This is not liquidity.

There is no seller liquidity below the current inside offer and there is no buyer liquidity above the current inside bid. In case this is not absolutely clear, here is a picture.

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As you probably know, a lot of the limit orders we see on the DOM are fake. Some liquidity is real and some is not. This means that the numbers on the DOM won't always help us. There are some presumptions we can make about the real liquidity above and below that will help us to understand the market.

Some people are PAID to provide liquidity. These people are often called "Market Makers" and in many cases they are, although HFTs muddy the water somewhat. Anyone can be a liquidity provider and get paid to place limit orders. Most people don’t as you need deep pockets to play that game. The Market Makers get paid to place these limit orders. As price moves up and down, they are effectively capturing the spread between the inside bid and offer. They do not capture the spread at each price point; no-one can do that. What happens is that the market tends to move back where it came from and the spreads are captured over time. Market Makers have deep pockets. If a market is roaring up with no retraces, then the Market Maker is going to be short at higher and higher prices; as the price moves down, they'll unload that position, capturing their rebates and the spread as that occurs. These people aren't going to remain totally passive if things go too far against them. They can and do play games to ensure they make money. They will push the market around and shake people out whenever the opportunity arises.

These people are not a charity. They are doing it solely for their own benefit. They will stop providing liquidity when it is most needed, which is one of the things that feeds a market crash. As markets move down rapidly, liquidity providers end up with a large offside long position and they stop providing buy-side liquidity which fuels the move down. Crashes are not caused by selling; they are caused by lack of buy side liquidity. This applies to all markets; look at the US housing crash of 2008 onwards, there was a complete lack of buy side liquidity. It was not that case that everyone decided to sell their houses at the same time!

Other traders, for whatever reason, will put in limit orders at better prices than current. These may be algorithms or they may be actual people. On the sell side, people can put in limit orders to sell for higher prices. On the buy side people can put in limit orders to buy at lower prices. This is common sense, buyers want to buy low and sellers want to sell high. A trader might have put his limit order in a minute, an hour, a day or a week ago. Various people will have put in limit orders at various times putting in various amounts of thought into the process. If you are day trading, it doesn’t follow that everybody else is day trading. You might see 5000 Bid at a level and think it is somebody trying to turn the market around; this may be the case OR it may be that someone put this order for 5000 contracts in a week ago as a hedge and they aren’t really concerned at all what happens in the next 5 minutes.

One thing that is always true is that there are ZERO buy limit orders above the current price and there are ZERO sell limit orders below the current price.

This is important - so let’s put it up in bold:

"There are ZERO buy limit orders above the current price and there are ZERO sell limit orders below the current price".

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Old September 10th, 2012, 01:43 PM   #38 (permalink)
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guppy View Post
When are these tools going to be avaialbel with multicharts?

Which tools?

A DOM similar to Jigsaw's?
Have you fill a request in Project Management?

MC was not built to retrieve such data but they are making changes. Next version, 8.1, will bring new tools, order flow tools such as footprint and cumulative delta.

I know the DOM is also going to get some new features but don't know if it's coming with version 8.1.

Let's wait...

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Old November 3rd, 2012, 02:35 PM   #39 (permalink)
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Thanks Dionysius, a great liquidity explanation.

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