Liquidity Sweeps in trading are one of the most important concepts in smart money (SMC). They help traders see false breakouts and identify the true trend bias of market. During Liquidity sweeps institutions trigger the stop losses of retail traders to create liquidity for themselves as most retail traders target range highs and lows for entries and stop losses.
Before I talk in detail about the liquidity sweeps. Let me clarify what exactly is liquidity.
What is Liquidity in trading?
By definition liquidity is how easily an asset can convert to cash without influencing the price of that asset. In an efficiently liquid market there will always be plenty of buyers and sellers who enable the market to move smoothly without causing gaps in its price. The asset price does not jump suddenly from lets say 20$ to 30$.
Since we are talking about the liquidity for trading markets lets understand liquidity through a real example of a chart.
The image show the difference between a liquid market and non liquid market. In a non liquid market there will always be price jumps at any time frame. The chart on the right is USD/TRY. Since most people trade in major pairs like the EUR/USD etc. Only a few are actively trading in USD/TRY hence we see the prices jump on the chart.
In a liquid pair like the XAU/USD or EUR/USD you will rarely see the price jumps because almost all the time during the market hours there are plenty of buyers and sellers available. So they are highly liquid pairs.
Understanding Liquidity Zones
Another concept you need to understand before getting deeper into liquidity sweeps is liquidity zones. Liquidity zones are levels in the market at which there are pending orders or stoplosses. These orders act as price magnets for the market and form either Break Of Structure or change of character. Large market participants target these zones to buy and sell their large orders at favorable prices.
Types of Liquidity Zones
There are two types or liquidity zones: External Range Liquidity (ERL) and the Internal Range Liquidity (IRL). The liquidity sweeps caused by institutional moves mostly happen at the External range liquidity zones.
External Range liquidity is the level of markets previous high or low. High represents the buy side liquidity (BSL). Similarly the previous low of the market is the sell side liquidity (SSL) zone. In the image below you can see I have clearly marked out the Buy Side Liquidity and Sell Side Liquidity zones.
Internal Range Liquidity is present at any zone or area within the range where there is either a Supply or demand zone or a fair value gap.
What exactly is liquidity sweep in trading?
Liquidity sweep in forex trading is a phenomenon in which the market makers target the stop losses of retail traders present at Buy side liquidity zones or sell side liquidity zones and then market reverses back after triggering the stops and creating liquidity for institutional orders.
There are two types of liquidity sweeps.
Buy Side Liquidity sweep
In this image you can see the price moves back to buy side liquidity and then after breaking the high the market stays there for 3-4 candles. This is the area where the market is sweeping the stoplosses of retail traders. Once there is enough liquidity the market takes a reversal as the institutional traders execute large sell positions. This is the phenomenon of buy side liquidity sweep.
Sell Side Liquidity Sweep
Similarly in the sell side liquidity sweep market goes back to the low level. This executes the pending buy orders present there. And the market instantly breaks the law to trigger the stop loss orders of retail traders. Once there is enough liquidity for market makers to execute their buy orders the market moves back within the range and moves in the bullish direction.
How to identify a liquidity sweep.
To identify the liquidity sweep first you should mark the high and low level of the range you want to analyze. The upper range will be the Buy Side and the lower level will be the sell side liquidity.
Now you have to wait for the market to take out either the BSL or SSL. In this image we can see the market reaches the buy side liquidity and then breaks the high. After that within 3-4 candles the market again comes back within the range. This is where the liquidity sweep happened and now you should look for short entries at this zone.
Trading the liquidity sweeps.
You should not trade liquidity sweeps by themselves. Instead you should rather use them as a confluence.
Here is a simple 4 step trading strategy that works very well.
Step 1 Analyze the overall trend
First of all you should do a technical analysis of overall trend of the market. For example, to trade the liquidity sweep at a 15 min time frame then first do the top down analysis at 8H, 4H and then 1H.
Step 2 Identifying the liquidity sweep.
Once you clearly know the trend then you should only look for the trades in the direction of the trend. For example here on this XAUUSD we can see the overall trend is bullish so we should only look for Sell side liquidity sweeps and only target the buy trade.
At 15 minute XAUUSD market structure the price swept the sell side liquidity. There are high chances of bullish reversal. Now once the market is back within the range we are ready to look for entry .
Step 3 Enter the trade
You should look for bullish entries like a bullish engulfing pattern, a Demand Zone or a Bullish order block. For example in this chart we can see the formation of this Demand Zone so we should put a buy limit at the high of the zone and stop loss at the low of this rally base rally demand zone or just below the liquidity sweep level.
Step 4 Set Target level and break even.
After the trade execution of your buy order you should set your target at 1:2 risk to reward ratio and break even as soon as the market reaches 1:1.
Difference between Liquidity sweep and liquidity grab
The major difference between a liquidity sweep and liquidity grab is the movement of the market near the external range of the liquidity zone.
During liquidity sweep the market approaches the buy side liquidity or sell side liquidity and then breaks the level.After that it stays above the level for a short moment and then goes back in the range sweeping the liquidity.
While in liquidity grab the triggering of stop losses is sudden. Market makers break the level and the returns back within the range in just one candle formation. The candlestick formed in liquidity grabs is mostly a pin bar or hammer.
If the grab is at sell side liquidity there will be a long wick below the body making a hammer pattern. If the liquidity grab is at the buy side liquidity of the range the long wick will be above the body of the candle forming a pin bar.
Common mistakes to avoid while trading liquidity sweeps
Never trade liquidity sweeps alone, always add a confluence of trend bias and look for clear entry signals. Avoid trading liquidity sweep in low volatile markets. Do not enter into a trade as soon as the liquidity sweep happens, always wait for the market structure shift for confirmation of trend reversal.
There is no one best timeframe for liquidity sweeps as it depends on your trading style. If you are a scalper you should target the time frames from 1 to 5 minutes. If you are a day trader then 15 minute to 1 hour timeframes are your best options. The main thing is liquidity sweeps are happening at all time frames.
No, you should not trade liquidity sweeps alone. They best traded alongside other confluences like the HTF analysis, Candlestick patterns, SND Zones and FVGs. If you are not able to find entry confirmation it’s better to let go of that trade instead of taking the risk.
There is no one best confluence for trading liquidity sweeps. But using higher timeframe analysis increases the likelihood of trade going in your favour. You can also use technical indicators like RSI to avoid taking buy trades if the market is breaking the Buy side liquidity in overbought conditions. Also you should avoid taking short trades if the market is making a sell side liquidity seep in over sold conditions.
