Diddly - Liquidity Zones

31 במרץ 2023

Diddly Liquidity Zones is an indicator to highlight where the liquidity exists in a market place.

What is Liquidity

Liquidity refers to the ability of an asset to be turned into cash. Cash is the more liquid form of any asset, whereas selling a house would take a little longer to liquidate and convert to cash.

Liquidity in financial markets is in essence based on the same principle and refers to how easily an asset can be bought and sold.

Liquidity in simple terms is the volume of participants who are willing to be involved in the market at any given time. Markets are based on auction theory, the more participants who want to buy at a certain price than sell, will dictate that the price goes up. As a result it is important to understand the role that volume has in financial markets, as volume will directly correlate to liquidity and supply and demand.


What does it mean?

Areas of abnormal liquidity and volume can lead to a price range where there is  high supply and demand, which in turn can become a zone that forms a support and resistance level in the future. As we all know what happens in the past does not mean it will happen in the future, but what liquidity zones will tell us is that in the past a higher number of people were interested in doing business at those prices, which is critical information when making trading decisions.

Although markets are based on auction theory, sadly we don't have the advantage of a traditional auction, where we are all sitting in a room putting our hands in the air when we are interested in paying x price for a particular item. In this environment it is very clear to see how popular the item for sale is and whether it is possible to pick up a bargain.

Being able to identify liquidity areas on a chart, provides an insight into market sentiment at a given price range. Also we have to consider that typically most retail traders participate in very liquid markets, where you can get in and out of a position with relative ease.

There are obviously exceptions, extremely low float stocks, but on the whole with liquid assets it takes some big orders to move price, especially with currencies and high float stocks. Understanding these principles helps us as retail traders identify where the big money is seeing a bargain, if buying or overpriced if selling.

However you identify liquidity, I hope you agree that it is an extremely important element to be considering before taking a trade. The last thing any trader wants to be doing if they can help it, is selling where the market perceives price to be a bargain and buying when overpriced.

Just as a side note, high and low "Float Stocks" refers to the number of shares in general circulation for buying and selling.


What is Diddly Liquidity Zones
 
This liquidity zones indicator in simple terms will plot zones on the chart and make an assessment of whether this is predominately buying or selling liquidity. Price will frequently come back to test areas of liquidity before making any further continuation in a specific direction. This is why liquidity zones are often described as areas of support and resistance.


How does it Work

To identify these zones the indicator is looking at a number of pieces of information predominantly based on volume.

• Volume
  
• Rate of Change
  
• Relative Strength
  

From these calculations the algorithm is then looking for the standard deviation away from the normal, to identify exceptions that then become the liquidity zones. These can be classified up to 4 levels, the first being the weakest exception to four being the strongest. By default 3 levels are displayed.


What is the Indicator Showing me?

The Liquidity Zones indicator comprises two basic elements:  Bull Zones and Bear Zones.

Zones that are not broken in the past are projected forward and can act as strong support and resistance levels that can also be used for targets or ignoring a trade due to lack of room above or below.

Here on AUDCHF 15 minute chart, during March 2023, it provides an example of the three indicator zone types. Details have been annotated on the chart.



The third type of zone is a “Trap Zone” which can be extremely powerful for identifying potential reversals. A Trap Zone can be either Trapped Buyers or Trapper Sellers. In essence it is a Zone that is identified, but price can never trade above or below in the direction of the zone.

As an example if a bear zone is identified and price fails to trade below the lower edge and bounces immediately out of the top. The trap is set and the indicator changes the zone from the default green (bull) or red (bear) zone to a different colour, which is orange by default.



As price moves higher away from the zone, those in their short positions start to feel the pain. The higher the move away before a retracement the higher the pain.  When the retracement finally comes and price returns to the zone, you will often see price bounce off the zone for the move back to retest the highs, following the same principles of support and resistance.

In this example above a resistance level is broken, which has been identified by a volume exception identified by the indicator, when price returns to that area it now becomes support as those traders in short positions look to cover at breakeven.

Here on EURUSD 15 minute chart, during the last week in March 2023, it provides a great example of a "trap zone" setup. Details have been annotated on the chart.




Usage

This indicator will compliment any existing strategy or could be traded as part of a support and resistance trading strategy. One of the great advantages of support and resistance is that levels and zones are identified ahead of time, so trades can be planned and considered well in advance.

There is also the advantage of where to stop out, once a support or resistance level is broken then we no longer want to be in that trade. We have to accept the facts that the market sentiment has changed and no longer sees price here as good value for bull zones or overpriced at bear zones.

You will sometimes see spikes of price through a zone, where the market has grabbed the liquidity in the form of stops on the other-side, which can be extremely frustrating as a trader, but important to understand that it does happen and why it is happening.

You will find liquidity zones on all charts, from the daily to the 1 second chart. The higher the timeframe, the wider the zones are. As a result we would not recommend planning an entry purely on a daily zone, but it is extremely useful information when drilling into the lower time frame charts. So using multiple timeframe analysis is a really useful technique when looking to understand a market.

There are a number of elements to consider before taking entries around support and resistance levels. The most important thing to remember is these levels have to break at some point, otherwise price would never go anywhere. Understanding that these levels can fail is important and is the reason we should always have clearly defined stops and manage risk.

You may also want to consider higher timeframe trend analysis to try and ensure you are trading with the trend. First and second retests work better as these zones will weaken over multiple retests as traders give up on that area, as it no longer is giving the reactions of price that it used to.

• The easiest entry method when working with support and resistance levels, is to place limit orders in the market. This is not a recommended approach, although it can be useful for traders who can't sit in front of charts all day. By taking this approach you would want to ensure that you are trading with the predominant trend on a higher timeframe and are in effect using these levels on a lower timeframe as pullback entries. You would also want to ensure that you have a wide enough stop to ensure that any spikes through don't stop out the trade, so using an Average True Range multiplier can be very helpful. The key point is don't oversize and manage risk.
  
  
• A better approach to identifying entries would be to look at price action on a lower time frame chart, once price has arrived at the level.
  
  
• A more conservative approach would be to wait for price to close outside the zone in the direction you want to trade on the signal chart and look for an entry on the retest of the top of the zone for buys or the bottom of the zone for the sells, with the stop the other-side of the zone.
  

For the purpose of examples we will focus on the last two methods, although there are many sources of information on how to trade support and resistance levels, so please don't take the above as the only way to plan or take entries.


Multiple Timeframe Alignment

Here on a stock asset MSFT (Microsoft), we have a zoomed out 15 minute chart. The top left is August 2022 and the bottom right is November 2022, which is quite a sell-off and there were many opportunities to the short side, although many traders would have been looking to see when this stock was at a bargain price.



Here on the 7th November 2022, there were the first signs of a potential change in market sentiment, as the indicator identified a Bull Zone on the 15 minute chart. At this stage the stock has been beaten up for a long time and there is a Bear Zone, above price - so not much distance to get a decent risk reward trade as yet.



Then on the Thursday of the same week, price came back to test the high of this previously created Bull Zone, after being rejected from the Bear Zone above.



So drilling into the 1 minute chart to find good risk : reward entries, price at the opening bell explodes through Bear Zones in the above chart and prints a big 1 minute Bull Zone. This on its own would be hard to trade, is it a fake out? price must surely retrace before a move higher, also there is a trapped buyers zone above price, so there will be a lot of liquidity and sell orders at that level.



Here again on the 1 minute chart, we see the breakout of the orange zone with a new Bull Zone (which is coloured blue, being a 2nd level zone). Now we just want to see this zone being confirmed by breaking the top and then we would look for entries on the retest.



Price action is now ready for taking a buy entry for a short-term swing trade as illustrated on the next chart.



About a month later the price hit the target, as shown on the 4 hour chart.



The target was set on the 15 min chart, being the next substantial level of a bear zone. Also on the 1 hour chart above, a big green bull zone of liquidity was identified, so there's a fair chance that price will come back to retest liquidity before a greater move away. The trade planner has been removed from this chart, so it is easier to see the printed zones, but the entry was at the 238.00



You will see since January 2023 there have been many opportunities on this stock using the 15 minute chart to find zones to trades and manage risk. The one thing that is clear in this chart is where the market sentiment was on this stock as it made the run-up to current price.



Alerting

Utilising the power of TradingView Alerts enables you to monitor many pairs, when you are away from your charts. You can set up alert for the indicator, by right-clicking on a zone that you see on a chart and choose the first option that appears on the menu "Add Alert to Diddly Zones". You can also perform the same operation from the indicator tile that appears in the top left corner of the chart.

Within setting you can choose to be alerted under the following conditions:

• When New Bull Zone has been Identified
  
• When New Bear Zone has been Identified
  
• When Price approaches a Bear Zone from below. Notifying traders that we are approaching a resistance level
• When Price approaches a Bull Zone from above. Notifying traders that we are approaching a support level
• When Price is Trading inside a Zone at a certain configurable time.
  

On the last point above: This is useful on a slightly higher timeframe, where large zones exist and you may want to be notified if this asset is trading in a zone at say the London open. You would have already been sent an alert telling you price was arriving at the zone, but that could have been a couple of days ago.

Key Settings

Within the indicator settings there are a number of options that are available to users. From changing the colours and their transparency of different zone types, to the number of exception levels that you want to see on the chart.

The most important ones that are in need of explanation are outline below:

To simplify the settings, the indicator is configured by using a similar analogy to driving style. The reason this is needed is because different assets and asset classes have different levels of liquidity, as a result the indicator requires some basic information to provide the best results. The principle being the faster you drive the more zones you will encounter.

To continue with the analogy, it is important not to drive too fast on a particular asset otherwise all you will see is zones and nowhere for price to go. If this is the case, slow the setting down or go to a higher time frame for a broader perspective.

Settings

"Determine Algo Driving Style" : Available options = "Slow", "Steady", "Sports", "Racing", "Rocket" (Default Setting = Sports)

So this is setting the speed of the indicator


"Turn on Turbo Mode" : True or False (Default Settings = True)

This setting will give the indicator a boost


"What type of asset is the Algo looking at" : Available Options = "Small Caps", "Large Caps", "Futures", "Currencies" (Default Setting = Currencies)

The only difference in these settings currently is a magnification element that is applied to the calculations, which is particularly relevant for highly liquid assets like currencies, futures and large cap stock. The only option that by default does not use the magnification element is Small Cap low float stocks, where liquidity is lower this setting is not required. This magnification can be change later in the settings under "Zone Identification Calculation Models"


Finally

We greatly appreciate the support and feedback from the Trading View community, and we are dedicated to continuing to improve our indicators with your support.

We want to help you manage risk, and that's why we emphasise that trading is risky and any technology used to support our trading decisions is based on information from the past. We encourage traders to take responsibility for their trading businesses and always prioritise risk management.

3 באפר׳ 2023

הערות שחרור

Apply max_bars_back to fix issue with backtesting using replay mode.