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Old 02-23-2012, 06:27 PM   #1

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Finding Liquidity

Hello guys,

Lately I have been very interested in how the market works (market microstructure) and been focusing on the essential stuff that move the market. And my idea is that market only moves in search of liquidity. Alas, my search is therefore on what liquidity is and how to find it. That is why I turn to my favourite forum in the world

I read a post around here a time ago (can't find it but doesn't matter) written by DionysusToast. He said (almost..) that the only way to know how a pullback is going to end is to find the liquidity. And as I think about it, that is true. But that works for every move in the market i.e. if it encounters enough liquidity and can't break thru it - it won't move up/down more.

So, I was thinking about the ways of recognizing liquidity. I am not thinking about if a market is liquid or not, I am talking about AREAS or CONCENTRATIONS of liquidity, and where to look for them. My main idea is to look at the DOM/T&S but since I am not very proficient in using it, this will take allot of time (obviously I am still going to do it). My questions are really; what tools do you think I should use? How should (with what idea) I look at this problem?

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Old 02-25-2012, 01:39 PM   #2

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Re: Finding Liquidity

Seriously, sit down and read time of sales and the ladder. Depending on how long you plan on studying it, you can learn alot in a week or 2.
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Old 02-26-2012, 10:20 AM   #3

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Re: Finding Liquidity

Quote:
Originally Posted by isamel »
And my idea is that market only moves in search of liquidity. Alas, my search is therefore on what liquidity is and how to find it.

But that works for every move in the market i.e. if it encounters enough liquidity and can't break thru it - it won't move up/down more.

My main idea is to look at the DOM/T&S but since I am not very proficient in using it, this will take allot of time (obviously I am still going to do it). My questions are really; what tools do you think I should use? How should (with what idea) I look at this problem?
I subscribe to the basic principle of auction market theory, namely that the market moves up and down in search of buyers and sellers; the job of a market is to involve as many buyers and sellers as possible, and it will move higher or lower to facilitate the most trade. This basically agrees with your idea.

There is only one real way to identify liquidity, and that is in retrospect, using volume. The order book may give short-term clues, but what you see on the DOM is not liquidity. It's available or potential volume, but until the deal is done, those orders are not commitments. Volume is the only thing we can objectively look at and observe that at a particular price or over a particular period of time, there was an increase in activity, and thus we can conclude that there was liquidity available.

But also consider that when directional movement of the market is clear, that not all pullbacks end with an increase in liquidity at the point of the turn. Sometimes we will see a sharp spike in activity near the turning point; other times we will see very little volume, and only when the original direction is resumed do we see activity pick up. So, it's not just to find liquidity (which would imply an increase in volume), but it can also be to recognize a lack of interest. Many reversal points consist of a big display of discovered liquidity (volume), followed one or two consecutive probes further with far less liquidity observed.

From a practical point of view, many people use "support" and "resistance" to identify past areas of observed liquidity, to potentially indicate current and futures areas. Since many people watch this and buy and sell the same areas, it can be said that an observation of past liquidity can lead to potential identification of future liquidity; though of course, many reasons exist to enter the market and thus it can be said that anything can lead to an increase of available liquidity at any price. As I mentioned above, the only real way to determine it is to observe it first, allowing others whose size is observable in the market to engage in price discovery, and then follow them, never leading ourselves.

I would love to hear others' thoughts on this, as it's at the heart of market movement.
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Old 02-26-2012, 10:43 AM   #4

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Cool Which Gold robot is Best

I am metals trader, I make good money by using financial and technical analysis but I struggle to find time for this, am looking to explore automated system in gold. I have searched the following 2 sites
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Old 02-26-2012, 11:33 AM   #5

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Re: Finding Liquidity

This could be a really interesting thread to follow.

My understanding, quite different to Joshdance's above, is that a market gravitates towards liquidity pools, and not away from them. So I expect areas of support and resistance to occur where there is little interest (or widespread agreement) from buyers and sellers. From a historical perspective, I would expect support or resistance to be accompanied by low volume. The absolute S/R point (one tick above the high/low) has zero volume of executed orders.

If you look at volume within a trading day, the above is exemplified by the gaussian distribution that MP traders pay so much attention to - the closer you move towards the high or low of the day, the less volume is typically executed at those levels. Ironically, of course, a lot of volume is often executed at the prior day's high/low.

However this is all just my understanding (and doesn't actually guide my trading in any concrete way), and I have had price action traders who spend a lot of time watching the DOM tell me that my understanding is misguided in other threads - so my word clearly isn't gospel!

Hope that at least provokes further discussion on this topic.

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Old 02-26-2012, 01:03 PM   #6

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Re: Finding Liquidity

Quote:
Originally Posted by BlueHorseshoe »
My understanding, quite different to Joshdance's above, is that a market gravitates towards liquidity pools, and not away from them.
BH, I didn't say that at all. See below for more.

Quote:
Originally Posted by BlueHorseshoe »
So I expect areas of support and resistance to occur where there is little interest (or widespread agreement) from buyers and sellers. From a historical perspective, I would expect support or resistance to be accompanied by low volume. The absolute S/R point (one tick above the high/low) has zero volume of executed orders.
I think it's this simple: it can be both. Look at the major lows from last year in the August time frame. Heavy accumulation, heavy volume. Again in October there is a final push lower, again on heavy volume but less than before. Heavy heavy market buying on that early October day in the afternoon that started the current bull market.

Sure, there is a low tick and a high tick, and unlikely that that high or low has lots of volume transacted. But typically there will be an area around where there is high volume. But not always. Sometimes the buying or selling on the way up or down just dries up... currently it seems we may have a drying up of buying before a significant move down, or we could have a spike of distribution first. The point is that it's not just one way. Observation tells us there's more than one way.

Quote:
Originally Posted by BlueHorseshoe »
If you look at volume within a trading day, the above is exemplified by the gaussian distribution that MP traders pay so much attention to - the closer you move towards the high or low of the day, the less volume is typically executed at those levels. Ironically, of course, a lot of volume is often executed at the prior day's high/low.
This is a whole other subject, but you're talking about a specific case--when a market is in balance. Even then, it's not so common to have a textbook bell curve. When the market is in balance in a particular range, awaiting information to determine the next direction, then yes, you will see this distribution.
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Old 02-27-2012, 09:19 AM   #7

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Re: Finding Liquidity

Hi Joshdance,

Reading back through your post it seems that I have probably misunderstood you and mis-represented what you were saying. Sorry about that!

I think that my statement relating to volume distributions is perhaps also unclear. By no means was I trying to imply that anything like a textbook bell-curve occurs with any regularity. I was suggesting that volume typically diminishes as the point of support or resistance is approached. There is a (slightly perverse) sense in which this is definitionally true: there is always less volume one tick below the low tick than there is at it. I am not claiming that this really occurs according to any ideal model. The 'bell curve' may well end up looking like a whale's silouette, but even a whale has a nose!

Rationally, I cannot find any reasons why a market trading at ask would cease rising other than because no buyer will consent to buy at one tick above the high, or because sellers start offering below it; in either case, there is insufficient liquidity at higher prices, and the market will trade towards where there is liquidity.

"Sure, there is a low tick and a high tick, and unlikely that that high or low has lots of volume transacted. But typically there will be an area around where there is high volume."

The point I am making is that the area won't just be "around" - it will always be above the low or below the high, and the market will have traded back towards that liquidity leaving the high or low tick as the tidemark we call support or resistance. The support or resistance occurs because the market has encountered a lack of liquidity, and has headed back the way it came to areas of higher liquidity.

Last edited by BlueHorseshoe; 02-27-2012 at 09:26 AM.
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Old 02-27-2012, 04:46 PM   #8

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Re: Finding Liquidity

In my opinion volume is important but it is more about who is providing the volume and when in the move the volume is being applied.

I subscribe to the theory that the "market moves with the least number of participants as possible". I use volume/lack of volume to signal the end of a trend not the start of a trend.

I think most new traders look at the market differently than what is actually happening, and as a result creates the "why am I always buying top's and selling bottoms?"

Most new traders see a pop in the S&P and say "look at the market going up I need to buy", but do not realize that the pop is a result of early entrants, the early entrants (read institutionals) push up the price with their demand, new traders enter at the end of the flury, and buy what the institutionals are selling, when the new trader money has dried up then the market pulls back, new traders feel pain and unload to the waiting instutions, and the market goes back up.

Same on the way down just reversed.

Markets go down on volume and up on absence of volume.

Look at the size of the "snap backs" in the S&P there is no coincidence that they are usually the average stop size of a new trader (retail trader).

We are all human and feel greed and pain the same way, there is no conspiracy to see our stops and pick them off, human nature does that for us!
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