SMC Trading Basics. Liquidity Zones & How to Identify Them
In the today's article, I will teach you the concept of liquidity zones and how to identify them properly, trading Forex, Gold, Crypto and Indexes.
Simply put, a liquidity zone is a certain area on a price chart where a significant concentration of trading volumes occurred.
Huge trading volumes signify the presence of big players: hedge funds, banks, etc...
Correct identification of liquidity zones is essential for smart money trading, because such zones provide the safest and the most profitable trading opportunities.
There are 3 common characteristics of a valid liquidity zone:
1. Huge volume spikes upon its test
Take a look at the underlined blue area on USDCAD.
We see sharp volume spikes when the market was testing that area.
2. Strong rejections from such an area with a formation of long wicks
Look how the price reacts to the liquidity zone on USDJPY.
We see multiple strong rejections from that.
3. Long consolidation within that zone
Bitcoin was "standing" on a liquidity zone for more than 3 weeks, barely moving while trading volumes were quietly accumulating.
4. Multiple strong bullish or bearish reactions to that area
Just look how many times the underlined area was respected by the buyers and by the sellers. That is a perfect example of a liquidity zone.
To underline a liquidity zone properly, follow these simple rules:
1. If the price is ABOVE the liquidity zone, its lower boundary
will be the lowest wick within that area and its upper boundary will be the lowest candle close. Such a liquidity zone will be called a demand area.
Here is the example of drawing a liquidity zone on GBPUSD.
The lower boundary of the zone is the lowest wick, while its upper boundary is the lowest candle close.
2. If the price is BELOW the liquidity zone, its upper boundary will be the highest wick within that area and its lower boundary will be the highest candle close. Such a liquidity zone will be called a supply area.
Here is the liquidity zone that I identified on Gold following our rules.
Remember, that you can identify liquidity zones on any time frame. However, the rule is that the higher is the time frame, the stronger is the liquidity zone.
I prefer to analyze the liquidity zones on a daily time frame.
Once you underlined liquidity zones, you should realize that within these areas, big players are expected to place their orders in the future.
For that reason, after the tests of such areas, a strong bullish or bearish movements will be expected.
Here is a huge liquidity zone that I spotted on GBPJPY.
Look at a strong bearish movement that initiated after its test.
Your task as a smart money trader will be to identify bullish or bearish confirmations and understand the intentions of big players. With experience, you will learn to recognize valid signals.
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