In the Inner Circle Trader (ICT) methodology, liquidity pools play a critical role in understanding price movements.
Liquidity pools are areas in the market where large clusters of buy or sell orders are waiting to be triggered.
These orders are typically located near swing highs and swing lows, representing buy stops or sell stops.
Large institutional traders, often referred to as Smart Money, use these liquidity pools to enter or exit the market efficiently.
In this detailed explanation, we’ll explore the concepts of buy stops, sell stops, and how institutions manipulate the market to target these liquidity pools.
1. What Are Liquidity Pools in ICT?
In the context of ICT, liquidity pools are areas where there are significant orders resting in the market.
These orders provide the liquidity needed for institutions to execute their large positions without causing major price disruptions.
Liquidity pools are typically found at key market levels such as:
- Above previous highs (where buy stops are located).
- Below previous lows (where sell stops are placed).
These pools act as magnets for price because institutions need liquidity to fill their large orders, and targeting these areas allows them to do so efficiently.
2. Types of Liquidity in ICT
1. Buy-Side Liquidity:
This is liquidity created by buy stop orders placed above a previous market high.
Traders who are short often place their stop-loss orders above recent highs.
When price approaches these levels, institutions will push the market up to trigger those stops, using the buy orders to fill their sell positions.
2. Sell-Side Liquidity:
This refers to sell stop orders placed below recent lows.
Long traders place their stop-loss orders below these levels.
Institutions push the market down to trigger these stops, using the sell orders to fill their buy positions.
3. Buy Stops and Sell Stops: What Are They?
1. Buy Stops:
These are stop-loss orders placed by traders holding short positions.
They place these orders just above a recent high, expecting that if the price reaches this level, the market will move against their position, triggering their stop to exit the trade.
2. Sell Stops:
These are stop-loss orders placed by traders holding long positions.
Traders set their stop losses just below recent lows, expecting the market to reverse upward, but if the price drops below the low, their stops are triggered to exit the trade.
4. How Institutions Target Liquidity Pools
Institutions, or Smart Money, have the power to move markets. However, they cannot simply execute massive buy or sell orders without causing significant price disruptions, which could work against them.
Instead, they need to target liquidity pools where enough opposite orders exist to fill their large orders.
Here’s how they do it:
1. Liquidity Grabs:
- Institutions will push the price toward liquidity pools (areas with clustered buy stops or sell stops).
- Once the price hits these levels, retail traders’ stop-loss orders are triggered.
- These orders provide the liquidity for institutions to enter the market with minimal slippage.
2. Stop Hunts:
- A stop hunt occurs when institutions intentionally push the market beyond a recent high or low to trigger stop losses and gather liquidity.
- Once these stops are triggered, institutions reverse the market in the direction they originally intended, after collecting the necessary liquidity.
5. Example of Buy-Side Liquidity Pool in ICT
Imagine the price of EUR/USD is trending upward.
Retail traders who expect the market to reverse place their short positions just below a significant swing high.
To protect themselves from losses, they set their buy stop-loss orders just above this swing high.
1. Buy Stop Orders Location:
Let’s say there’s a swing high at 1.1000.
Retail traders place their stop losses at 1.1010, expecting the price to reverse below this level.
2. Institutional Target:
Institutions know that many stop orders are sitting above 1.1000.
They push the price up beyond 1.1010 to trigger those stops.
3. Liquidity Grab:
Once those buy stops are triggered, the market surges upwards briefly, allowing institutions to sell into the buying pressure created by the triggered stops.
4. Price Reversal:
After the liquidity is taken, the price reverses and moves downward, as institutions have completed their sell orders and the buying pressure from the retail stop losses has been exhausted.
Key Takeaway: The institutional move above the swing high was not a real trend continuation but a liquidity grab to trigger buy stops and create an opportunity for institutions to fill sell orders.
6. Example of Sell-Side Liquidity Pool in ICT
Now let’s look at a downtrend example.
The price of Bitcoin has been moving downward, and retail traders expect the market to hold support at a significant swing low.
They place their buy positions above this swing low, with sell stop-loss orders below it to protect against further downside.
1. Sell Stop Orders Location:
The market makes a swing low at $25,000. Long traders place their stop losses at $24,900, expecting the market to reverse upwards.
2. Institutional Target:
Institutions know there are many sell stops below $25,000. They push the price down below $24,900 to trigger those stops.
3. Liquidity Grab:
The sell stops are triggered, providing liquidity for institutions to fill their buy orders.
Price briefly drops below $24,900, allowing institutions to enter long positions.
4. Price Reversal:
After the liquidity is taken, the market reverses upward, as institutions have used the sell-side liquidity to accumulate buy orders.
Key Takeaway: The drop below $25,000 wasn’t a continuation of the downtrend but a move to collect sell-side liquidity, enabling institutions to enter long positions at favorable prices.
7. Liquidity and Institutional Order Flow in ICT
Institutions always need to balance two things:
- Maximizing profit: They want to execute their trades at the best possible prices.
- Minimizing market impact: They need to enter or exit trades without moving the market too much against themselves.
By targeting liquidity pools, they ensure there are enough buy or sell orders to absorb their large positions.
This keeps price movement relatively stable while allowing them to fill their orders efficiently.
8. Trading Liquidity Pools Using ICT Concepts
ICT traders use liquidity pools to their advantage by:
1. Anticipating Liquidity Grabs:
ICT traders know that price will often move to take liquidity before reversing.
They wait for these moves to occur and trade in the direction of the institutional flow after the liquidity has been taken.
2. Entering After Liquidity is Taken:
Rather than entering trades at the highs or lows, ICT traders wait for liquidity grabs to occur (e.g., stops being triggered) and then look for reversal signals to enter trades in the opposite direction.
3. Using Order Blocks:
After liquidity is grabbed, price often returns to an order block (an area where institutions previously placed large orders).
These areas are key points of entry for ICT traders.
9. Conclusion
Liquidity pools, represented by buy stops and sell stops, are crucial in ICT trading because they provide the necessary fuel for institutional players to execute their large orders.
By understanding how and why Smart Money targets these pools, ICT traders can better anticipate market moves, avoid common retail traps, and align their trades with the flow of institutional order execution.
Whether you’re targeting buy-side or sell-side liquidity, mastering this concept is essential to becoming a successful ICT trader.
Leave a Reply