The financial market is a complex ecosystem governed by dynamics that often defy a superficial reading. Every price movement is the result of the interaction between supply and demand, between the presence or absence of executed orders. Some phenomena emerging from this continuous negotiation have assumed a central role in the strategies of professional traders. Among these is the so-called
liquidity void, a concept rooted in order flow analysis that proves essential for understanding certain sudden price accelerations.
We'll discuss it here. We'll define liquidity void, explain its causes, how it can be used operationally, and the risks it entails.
What is a liquidity void?
The term liquidity void literally translates to "void of liquidity." It refers to
an area of the chart where the price moves with extreme speed, leaving behind a sort of "gap" devoid of significant trading. In other words, it's the result of a lack of sufficient opposing orders to absorb buying or selling pressure at a given moment.
From a graphical standpoint, a liquidity void appears as
a candle or a series of very wide candles lacking substantial retracements. The absence of consistent trading along that movement signals that the market has moved from one price level to another without encountering significant resistance.
Causes of liquidity void
Multiple reasons can lead to the formation of a liquidity void:
- Sudden economic or political news: unexpected macroeconomic data, central bank statements, or geopolitical events can trigger abrupt movements that leave behind areas devoid of orders.
- Large institutional orders: so-called big players, such as hedge funds and investment banks, move imposing volumes that, if introduced into a low-liquidity market, create evident imbalances.
- Reduced liquidity sessions: overnight hours or holiday periods with limited participation can amplify the effect of sudden movements.
- Breakout of key technical levels: when the price breaks a widely watched support or resistance, pending orders can activate en masse, emptying the surrounding area of sufficient counterparties.
The consequence is a rapid and decisive movement that leaves a portion of the chart "uncovered." According to many analysts, these areas have a high probability of
being revisited by the price in the future because they represent zones where the market hasn't traded sufficiently to stabilize the price.
How to use liquidity void
Liquidity void is not just a phenomenon to observe; for many traders, it's an operational tool that can provide useful signals for planning market entries and exits. The basic logic is simple: liquidity voids tend to be filled because the market continually "seeks"
areas to complete missing trades.
But here are the steps that allow you to exploit liquidity void:
- Identifying the void: the first step is to graphically identify an excessively rapid movement characterized by wide candles lacking significant shadows.
- Tracing the area: mark the price levels that delimit the liquidity void, from the starting point to the endpoint of the sudden movement.
- Waiting for a return: observe the market to see if, at a later time, the price returns to visit that area, filling the void left behind.
- Planning the entry: position entry occurs when the price re-enters the marked zone, aiming for a significant reaction.
But let's give an example.
Consider the EUR/USD exchange rate, which following an unexpected macroeconomic data release, abruptly moves from 1.1000 to 1.1070. The entire movement occurs in a few minutes, with a candle lacking intermediate retracements.
Here, the area between
1.1000 and 1.1070 is considered a liquidity void.
In the following days, the price begins to retrace. Upon reaching 1.1050, many traders hypothesize a complete return towards the 1.1000–1.1020 area.
Noting this,
they enter short at 1.1050 with a target at 1.1010, setting a stop loss at 1.1085 to contain risk.
If the market fills the void, the operation yields a profit of 40 pips, while the potential loss is 35 pips.
Risks of liquidity void
Although it may seem a simple concept to apply, liquidity void entails significant pitfalls. Relying solely on this strategy without considering the market context can lead to disappointing results. Above all, it exposes one to significant risks.
- Failure to close the void: not all liquidity voids get filled. Some remain open for months or even years, especially if originated by long-term fundamental events. Basing one's operations on the belief that every void must be filled is a costly mistake.
- Wrong timing: even when the void is filled, the timing is unpredictable. It can take hours, days, or weeks. Entering too early exposes one to heavy drawdowns that are psychologically and financially difficult to sustain.
- Risk of false signals: movements similar to a liquidity void can actually derive from structural trends rather than a true momentary imbalance. In such cases, waiting for a return that doesn't happen leads to prolonged losses.
- Impact of volatility: liquidity void operations often take place in high-volatility contexts, such as during economic data releases. These scenarios, if not managed precisely, increase the risk of slippage, executions at worse prices, and skipped stop losses.
- Requirement of advanced skills: finally, exploiting liquidity void is not an operation suitable for everyone. It requires market knowledge, ability to read order flow, and mastery of risk management dynamics. Without an adequate level of experience, the probability of making mistakes increases significantly.
