Understanding Order Blocks in Forex Trading
Unlocking Profit Potential
Most intermediate traders must have heard of “SMC”, “order blocks” “Liquidity gap,” and other advanced forex trading jargon. We will be delving into order blocks and how to identify what best order blocks to trade in the financial market
Note: This is for educational purposes, and you should educate yourself on the basics of forex trading before applying these concepts.
What is an order block?
An order block in financial trading is simply an accumulation of different orders (buy and sell orders) in and around a particular price on the price chart. Order blocks are caused by large financial institution traders placing significant pending orders at a particular price.
Order blocks, when properly identified, give away key support and resistance levels that can be used as entry or exit points for traders, as these are levels where institutional traders either exit or enter the market.
Primary rules of order blocks:
- We consider the last candle that creates the inefficiency as the order block zone because decisions are made during this candle.
- The candle must be at the start of an impulsive move or in the middle of the impulsive movement.
Characteristics of a Good Order Block
A good order block must possess these characteristics to be a valid order block. And also considered tradeable.
1. It must create inefficiency.
Inefficiency occurs when there is a sharp or sudden movement on the price chart in either direction, creating gaps between the wicks of the candles.
2. Must lead to a break in structure or change of character:
A valid order block must either lead to a change in the character of the price chart or a break in structure (breaking a previous low or high).
3. Must be unmitigated:
A valid order block must be unmitigated to be considered a good and valid order block. An unmitigated order block is an order block that has not been previously tapped into by a reversal candlestick.
This is very important because good order blocks are for one-time use only. The order blocks above are no longer valid as they have been mitigated.
Conditions to Identify High-Quality Order Blocks
There are several conditions that must be met before high-quality order blocks can be identified. Here we go.
- Market structure: Valid order blocks are dependent on the several market structures that precede the OB (order block).
If there was a previous order block that was unmitigated, chances are the previous order block will lead to a liquidity grab and will become the valid order block and not the most recently identified order block.
While the presence of equal lows before the impulsive move makes a recent order block a valid order block,
2. Market Volatility and Spread: When trading order blocks, you should consider the market volatility and the spread of the currency pair or commodity you are trading. Most winning trades happen on highly volatile days and sessions, which are usually during the midweek and during the London and New York sessions. The spread of the currency pair plays a vital role, as wide spreads will make you miss out on certain trades and also cause your stop loss to trigger early.
3. Market trends and recent order blocks: Order blocks are best traded in a trending market rather than a ranging market. It is more successful in a trending market because you are not fighting against the trend but flowing with the trend.
How to trade order blocks:
Trading order blocks can be confusing, but they are simple if you understand the concepts and characteristics of a valid one. Here are the three simple steps to follow when trading order blocks:.
1. Identify a valid order block.
2. Place your order at the beginning of the zone.
3. Set your stop loss at the end of the zone.
4. Apply the 2R rule.
Following the primary rules and characteristics of an order block, you can easily identify a valid order block and then place your trades while applying proper risk management skills.
It is vital that you apply the 2R rule so that even with a low win rate, you can still remain profitable in the long term.
Conclusion
Order blocks have a huge effect on the price movements in the markets due to the large sizes of the institutional limit orders. They also lead to market imbalances because they absorb more liquidity, which also causes high price volatility in the market. They also give a clear indication of the market sentiment of the big market players.
