I. Smart Money vs. Dumb Money
We’re trading against entities that spend their entire life studying financial markets and invest billions into knowledge and working systems. The difference here is that Smart Money have a deep knowledge of how Dumb money work while the last one don't know which is the concept of Smart Money. Smart Money know that Dumb Money uses classic trading indicators the wrong way (buy when RSI is low and sell when RSI is high, for example) and they also know that people rely on emotions to make their financial decisions. SM use algorithmic trading instead: computer programs or algorithms are used to execute trades based on predefined criteria such as price, timing, quantity, or mathematical models. It removes the emotional part, and it’s also the one in which smart money invest the most capital. The majority of algorithms work on “breakout” strategies : trades are executed when asset prices surpass predetermined support or resistance levels. This strategy simply capitalizes on the influx of buy and sell orders from both retail traders and algorithms at these critical levels, aiming to capture liquidity concentrated within those areas.
Orders, concretely speaking, produce liquidity. A market is deemed liquid when the assets tradable in that specific market could be exchanged quickly. This is the key concept this content revolves around and the magnet for every financial market. Thus, Smart money manipulate the market to reach important HTF points, grabbing liquidity and making retail traders poor. The more orders, the more liquidity ; the more liquidity, the more potential profits for SM.
II. AMT : Fair Value, Imbalances and FGV
Given the previous topic, we must take it upon ourselves to find out how to recognize specific regions with the use of some tools and how to take advantage of them. As you know, there are 2 opposing forces in the market: buyers and sellers. When buyers are aggressive, the price rises, searching for new sellers. On the opposite, when sellers are aggressive, the price falls, searching for new buyers. From this is born the concept of Auction Market Theory (AMT): when aggression is balanced, the market finds a Fair Value and will remain in such condition until a major event changes the aggression of buyers and sellers, causing an imbalance.
The “Fair Value” is simply a price area that facilitate most trades between market participants, and results in price trading in a tight range and on a higher volume. Once the aggression resumes on one side of market participants, it creates an imbalance which causes a spike in price, to the upside or the downside. The volume will likely be low as the directional impulse (bull or bear) has one preponderant force. Imbalances can act as “magnets” for the price to search for liquidity. This phenomenon is observable on charts through the presence of wicks that grab liquidity into the imbalance zone. It’s also highly probable that price ultimately rebalances the imbalance created in the past, breaching through that area to reach a past Fair Value zone. Statistically speaking, the market is more likely to find a reaction in a zone where there was demand, because the market perceived that area as fair value.
Another crucial aspect to consider is that we don’t know when imbalance zones will be rebalanced. It could take days, weeks or even months before seeing the price re-balancing the imbalance. This means that you don't have to sell (if break to the upside) or buy (if break to the downside) after the price has created an imbalance, as the market could produce another impulse and you'll likely to get “cut” from the trend, missing out on profits.
Fair Value Gaps (FVG) and Imbalances are part of the same concept but are different things. An imbalance relates to a one-sided increase in aggressiveness from market participants, resulting in notable price fluctuations. A Fair Value Gap is the representation of an imbalance and is the gap observed on price charts. To be precise, it’s the “‘middle area” created between the wicks of the last and the following candles.
To assess the importance of an FVG, you must take into account several factors, as per the infographic :
- Mitigation
- Confluence
- BOS
- Reaction
- Priorities
III. Supply & Demand | Dominance & Momentum | Premium, Discount and Equilibrium
Supply and demand zones, contrary to support and resistance levels, are areas (not finite numbers) on a price chart where the balance between buyers and sellers may shift, due to the presence of a lot of pending orders. These areas are way more important than support/resistance ones and you can use them to spot potential reversals on the upside/downside.
Personally, I use the concept of AMT, analyzing the balance or imbalance of the market. When the market is balanced or in consolidation, at some point an impulse is being created by buyers or sellers. The point from which the impulse starts, is called “Origin Point” and becomes my key reference to consider a potential demand zone (impulse to the upside) or a potential supply zone (impulse to the downside).
The Supply Zone is an area where sellers outnumber buyers, causing the price to drop. The Demand Zone instead, is an area where buyers outnumber sellers, causing the price to rise.
2 key things to remember:
- I could have included the wicks of the candles in the demand zone and it would have still been valid.
- The more a supply or a demand zone is tested, the weaker it becomes as sell or buy orders get absorbed.
The ideas of Dominance & Momentum revolves around the classic market structure, with financial markets having 2 main directions for the trend: Bullish or Bearish. Each high or each low can help us individuate where sellers and buyers have entered the market. While wicks are important (liquidity grabs) we watch for the bodies of the candles to gauge relative strength: HTF closures above/below. The concept of Dominance is extremely easy to understand and can help you decide if it’s worth selling or buying.
This chart shows a clear Bitcoin downtrend, with multiple lower highs and lower lows. The directional bearish impulse starts from each high (red bubble) flashing more supply than demand and therefore pushing the price down.
At some point, buyers enter the market (green bubble) but cannot overcome the past sellers’ dominance zone (notice the lower highs) becoming a new level in which sellers push the price down again, so transforming into a new sellers dominance zone.
To gauge the strength of the buying or selling signals, you must look at the Momentum. In trading, momentum is nothing else than the speed with which the price reaches the sellers or buyers dominance. The less time it takes, the stronger the momentum for buyers or sellers. The more time takes, the weaker the momentum.
In this example, the buyers took 3 days to push the price higher (without violating the sellers dominance), while sellers just took 1 day to violate the buyers dominance. This was a clear sign that sellers was in momentum and in complete control, helping us to consider staying away from the market or opening a potential short position.
We previously saw that every financial market moves from the simple law of supply & demand. From those levels, however, we need to elaborate a concrete strategy that can help us to make good financial decisions and answer these questions :
"At which price I would prefer to buy this asset?" "At which price I would prefer to sell it?"
Basically, you want to:
- Buy at Discount (low) -> below 0.5 Fibonacci
- Sell at Premium (high) -> above 0.5 Fibonacci
- Have less interest in buying/selling at an intermediary price (Equilibrium) -> 0.5
The more the price goes to the premium area, the more smart money will be inclined to sell. Conversely, the more the price goes down to the discount area, the more smart money will be interested in buying.
IV. Order Blocks and Breaker Blocks
The classic definition of Order Blocks (OBs) is that they are specific price areas where institutional trader have placed significant buy or sell orders. These zones, that are created by the accumulation or distribution of large quantities of an asset, can act as strong support or resistance levels in the market. They can be associated with these terms, although they have an advanced and higher level of accuracy.
But why do they work? Large banks and institutions with substantial funds cannot place all their orders at once. If they did, this would cause rapid price movements, preventing them from executing their orders at favourable prices. Instead, they place their orders gradually in the market and once the orders are ready, they often use significant news events to trigger a sharp price movement. Rapid movements create imbalances, which appear on the chart as gaps. During this impulsive move, not all orders may be filled : the price then returns to the original OB to restore market equilibrium, balance supply and demand, before continuing the initial movement.
To have a valid OB, 4 conditions must be respected :
1. Liquidity grab
2. Significant candle body
3. BOS
4. Imbalance
An order block gets validated once it presents a liquidity grab before its formation. To make the OB stronger, thus where the price can react the most, we will also search for a strong body of the candle that constitutes the order block. A bigger candle with no or very short wicks makes the OB more reliable as the impulse generated by the buyer or the seller part has been more violent. In order to have a valid OB, it needs to be followed by a break of structure (BOS) and an imbalance.
We’re also looking for unmitigated OBs, because the liquidity in that area hasn't been tested, therefore the likelihood of seeing the price revisiting it increases, offering a good potential entry in the direction of the predominant trend. A small wick or just a quick and light touch could be seen not as a proper mitigation, therefore making the OBs still relevant. A long and violent wick or a strong candle body toward the OB instead, contribute to make the OB properly mitigated, reducing its importance when we will look at those areas.
Also remember : the higher the timeframe, the more powerful the OB will be.
Breaker blocks are previously failed order blocks that become key supply and demand zones. The rules are the same for OBs, so they occur respecting the above mentioned laws, especially after a sweep of liquidity and a BOS.
Example : The strong bearish impulse that generates the OB at some point reverses back up, “melting” (not a proper melt but you grasped the concept) the OB, thus creating a MSS (Market Structure Shift) with the break of the previous high (small yellow circle).
The price then uses the OB as a demand area to bounce and continue the trend to the upside, forming the BB (breaker block). Of course, this situation can also happen to the downside therefore with a bullish impulse that creates the OB, the price that pushes down with violence and uses the previous OB as a supply area to continue the trend down.
In this last example we can spot a clear OB that respects all the “rules” previously mentioned. But, there’s another concept to add for more completeness: the internal OB. As you can see from the chart, I plotted the whole and main OB, but if you take a closer look there’s another smaller OB inside of it, which is the internal one.
Its purpose depends on the context (MS, timeframes etc) but we can use these areas to potentially assess more accurate zones in which the price can react and therefore front-running the wider area of the main OB.
