Article Understanding Liquidity and Market Pullbacks

T2W Bot

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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...

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Mr. Charts

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One of the best t2w articles I've ever read. A lot of time and thought have gone into it.
 

DionysusToast

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The images didn't come out too well on the article.

Here are the full size images:

removed - links are in the article now (can click to enlarge) thx T2W

Cheers

DT/PD
 
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Tradernopoly

Newbie
7 0
MONEY FLOW INDEX ;LIQUIDITY??

hi there peter, i would just like to say that you have touched on a amazing topic, thank you so much for this post.But what im trying to explore is could you gauge the liquidity of a pair,stock,futures, by using the money flow index...e.g. assuming that when the MFI line crosses the middle point from below, you would anticipate it to be a long movement...Then in terms of liquidity, you would assume that at this point you would determine if there are any orders to influence money to fill them?
If you would share your thoughts on this i would truely appreciate it...

Regards

Tradernopoly
 

BankRobber

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Great article! Kudos to you
 

DionysusToast

Legendary member
5,963 1,501
Re: MONEY FLOW INDEX ;LIQUIDITY??

hi there peter, i would just like to say that you have touched on a amazing topic, thank you so much for this post.But what im trying to explore is could you gauge the liquidity of a pair,stock,futures, by using the money flow index...e.g. assuming that when the MFI line crosses the middle point from below, you would anticipate it to be a long movement...Then in terms of liquidity, you would assume that at this point you would determine if there are any orders to influence money to fill them?
If you would share your thoughts on this i would truely appreciate it...

Regards

Tradernopoly

I use the Cumulative Delta (CD)...

Market Buys Orders - Market Sell Orders.

I use this because it is market buy & market sell orders that consume liquidity. So, when I see a pullback, I look at the CD to gauge participation. It is not an exact science:

Market moves down and CD doesn't - no participation of market sellers, it's a vacuum.
CD moves down and market doesn't - participation of market sellers BUT liquidity is absorbing the selling, it's a thick floor
CD & Price move down - a fairly regular down move.

I'm also a Tape Reader, so I see this happening over time, the mix of buy market/sell market orders and the impact those orders have.

The money flow index (MFI) I believe is based on price and volume which doesn't tell us anything about the side that the volume is on. It also doesn't tell you how much volume traded at any one point.

In my opinion, you'd get a lot more out of just using volume bars than the MFI. You'd certainly get much more from CD.
 

PutaMadre

Newbie
1 0
Vaidas

Thanks Peter! Enjoyed the reading very much! So as i far i understand lack of liquidity creates volatility in market, liquidity and volatility is kind of oposite things?
 

tuscan

Member
91 2
Thanks for the article, great description of what "market makers" do...
A terminology issue... if you call a sum of limit orders a liquidity I'm not sure this is a right definition of it. Of course there are those who professionally provide liquidity and they are "providing prices" for market price-takers, by limit orders, but price taker also provides liquidity - for the ones who are executing orders by limit orders, who are not "market makers".
 

bbmac

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I just wanted to add my thanks and appreciation of an excellent article. It certainly made me think further about the process of price movement and I think there is a tendency in my type of trading to over generalise without a thorough knowledge of the mechanics of price movement an example of which you show in the article. This is probably because we don't use CD / DOM etc so don't actually see the mechanics played out in respect of actual orders being placed, and pulled or matched.

I wonder when you get a minute whether you could comment as below ?

You mention in it: '...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....'


Further down on page 1 of the article: '..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!...'

These are important observations and whilst discussing different markets are making points about the subject of price movement. On the surface these 2 statements may though appear contradictory? In the 2nd statement the assertion is that prices move down because of a lack of buyers at each 'price floor' not because everyone is selling...but in the first statement the assertion is that there is no such thing as a an imbalance of buyers and sellers that causes price to move and that as price moves all orders are matched.

Am I right to say re the 1st statement and with reference to the 2nd that whilst buyers and sellers are matched at each price floor/ceiling should there (in the example of a falling market) be no buyers at a certain price floor and there are still sellers price will continue to drop until it finds a price floor where there are buyers and at this level the sellers will be matched by the buyers ?

My point is and continuing with the U.s Housing market crash of 2008 onwards that you use - that even though there was no buy side liquidity at each price floor as price moved down there must have been sellers trying to get matched at these price floors because no buyside liquidity coupled with no sellers would not necessarilly move price. Ie would price not stand still in the event of no buyside liquidity but also no sellers?

Hope you see what I am getting at ?

Thanks.
 
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bbmac

Veteren member
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Pullbacks

On the specific subject of the article ie understanding-liquidity re market pullbacks I found it particularly enlightening and indeed could have used such analysis on Friday re gbpusd.

As you probably know I look for a number of repeating price action and derived tech set-ups to get involved with a trend. The hidden divergence based set-ups I look for are at potential sbr/rbs (support becomes resistance/resistance becomes support) that exists on the next higher t/f to the set-up and on which the trend being entered after the pullback at least exists on.

On Friday I had just such a set-up - perfectly formed of itself except it didn't set-up at any poteential rbs (resistance becomes support) on the next higher t/f, and I do see these from time to time such that it has resulted some time ago in adding a rule to trade them should the trend fulfill certain criteria -centred around looking for market conditions like Friday's strong upmove in gbpusd. I still don't like them though and pass on more than I trade beacuse of a like of confidence in them, ie it lacks the confidence that a potential sbr/rbs gives. How useful it would be in the spot forex market to have such analysis derived from reliable data as you shave showed in the article.

The ' is it a pullback/extended pullback or more/complete reversal ' connundrum is one that must perplex all tech traders ? In a sense without the kind of analysis you show all we can do is look at market conditions and make reasonable working assumptions should our edges to get involved in the trend after a pullback develop.

G/L

oh1xlx.jpg
 

DionysusToast

Legendary member
5,963 1,501
I just wanted to add my thanks and appreciation of an excellent article. It certainly made me think further about the process of price movement and I think there is a tendency in my type of trading to over generalise without a thorough knowledge of the mechanics of price movement an example of which you show in the article. This is probably because we don't use CD / DOM etc so don't actually see the mechanics played out in respect of actual orders being placed, and pulled or matched.

I wonder when you get a minute whether you could comment as below ?

You mention in it: '...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....'


Further down on page 1 of the article: '..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!...'

These are important observations and whilst discussing different markets are making points about the subject of price movement. On the surface these 2 statements may though appear contradictory? In the 2nd statement the assertion is that prices move down because of a lack of buyers at each 'price floor' not because everyone is selling...but in the first statement the assertion is that there is no such thing as a an imbalance of buyers and sellers that causes price to move and that as price moves all orders are matched.

Am I right to say re the 1st statement and with reference to the 2nd that whilst buyers and sellers are matched at each price floor/ceiling should there (in the example of a falling market) be no buyers at a certain price floor and there are still sellers price will continue to drop until it finds a price floor where there are buyers and at this level the sellers will be matched by the buyers ?

My point is and continuing with the U.s Housing market crash of 2008 onwards that you use - that even though there was no buy side liquidity at each price floor as price moved down there must have been sellers trying to get matched at these price floors because no buyside liquidity coupled with no sellers would not necessarilly move price. Ie would price not stand still in the event of no buyside liquidity but also no sellers?

Hope you see what I am getting at ?

Thanks.

Good points there. The way I see it, the imbalance is not so much the number of buyers & sellers but rather the price that they are willing to transact.

You can't have a seller without a buyer.

If you decide to sell something then you can go out with a limit order and say "here's the thing I want to sell, give me $10 for it". You use $10 because you heard that this was the last price the item sold for.

Then you can wait for someone to take you up on that offer.

If no-one takes you up on that offer, you have a choice.
1 - Drop your price
2 - Take it off the market

If the best bid is $5, then you might just wait it out. Other sellers may be willing to sell for $5 in which case last price drops to $5. A lack of buy side liquidity above $5 caused the price to drop.

Now - in this case of course, the price didn't really 'drop'- it's just that 2 people transacted at $5. Sure, if you put the price on a chart, there will be a downward slop from $10 -> $5. But at this point all that is happened is 2 people did a deal at $5. The next transaction may well be at $10. Chances are that this will not be the case because other buyers just saw the product go for $5 and so won't be willing to pay much above that.

With the housing crash, we know that people buy & sell houses all the time. Obviously, there was a lot of people that borrowed money they couldn't pay back but ignore that for a moment. Consider a healthy market with stable prices where there is buying and selling. If 50% of the buy side liquidity drops down to much lower price levels, then price will drift down. Sellers all have different motivations to sell. Some will hold on, some wont be able to. If enough of buy side liquidity side seeks better prices, the price will drift down to those prices.
 

DionysusToast

Legendary member
5,963 1,501
Re: Pullbacks

On the specific subject of the article ie understanding-liquidity re market pullbacks I found it particularly enlightening and indeed could have used such analysis on Friday re gbpusd.

As you probably know I look for a number of repeating price action and derived tech set-ups to get involved with a trend. The hidden divergence based set-ups I look for are at potential sbr/rbs (support becomes resistance/resistance becomes support) that exists on the next higher t/f to the set-up and on which the trend being entered after the pullback at least exists on.

On Friday I had just such a set-up - perfectly formed of itself except it didn't set-up at any poteential rbs (resistance becomes support) on the next higher t/f, and I do see these from time to time such that it has resulted some time ago in adding a rule to trade them should the trend fulfill certain criteria -centred around looking for market conditions like Friday's strong upmove in gbpusd. I still don't like them though and pass on more than I trade beacuse of a like of confidence in them, ie it lacks the confidence that a potential sbr/rbs gives. How useful it would be in the spot forex market to have such analysis derived from reliable data as you shave showed in the article.

The ' is it a pullback/extended pullback or more/complete reversal ' connundrum is one that must perplex all tech traders ? In a sense without the kind of analysis you show all we can do is look at market conditions and make reasonable working assumptions should our edges to get involved in the trend after a pullback develop.

G/L

oh1xlx.jpg

Totally agree and I think the conundrum is probably a harder one to resolve for Forex traders because of the fact it's not centralized.

With markets that trade on a central exchange, you have volume and delta studies that at least give you some idea of the participation in the pullback/new trend. It's not an exact science but it certainly does help in terms of confidence to push the button.
 

barjon

Legendary member
10,705 1,809
bbmac

As the article and toastie say - " You can't have a seller without a buyer." - thus you can't have an imbalance of buyers and sellers.

'Course you can have an imbalance in the number of people wanting to buy as opposed to wanting to sell and that's the crux of it I think.

jon

ps: great article btw
 

DionysusToast

Legendary member
5,963 1,501
A bit of a diversion...

You can have 2 equal weight people sitting on opposite ends of a see-saw. If person A is sitting right on the end of his side but person B is only half way across his side, then the see-saw will be down on person A's side.

Is that not an imbalance?

In some ways, the imbalance is a semantical argument.
 

Dom1

Junior member
37 4
So buying/selling pressure or let's call it Desire (market orders) working through supply/demand (liquidity) . Price will reverse when this imbalance is reversed (eg. increase selling pressure no buying liquidity when price begins to drop after a rise) but will reverse again in a timely manner in the case of a retracment . If reversals fail you have a trend. Desire and availability is out of balance.


bbmac

As the article and toastie say - " You can't have a seller without a buyer." - thus you can't have an imbalance of buyers and sellers.

'Course you can have an imbalance in the number of people wanting to buy as opposed to wanting to sell and that's the crux of it I think.

jon

ps: great article btw
 
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