ADVANCED · ENGLISH · FREE

2. Liquidity

Observed and assumed

Market liquidity is the ability to execute a particular quantity at acceptable prices. The spread and available order-book depth describe it only partially. Visible volume can be withdrawn, spread across venues or hidden by execution rules.

"Liquidity above the highs" usually means a hypothesis about clustered stops and breakout orders. A public chart does not reveal the exact quantity of those orders. Distinguish actual order-book or trade-tape data from assumptions about where orders are located.

A stop order is often held outside the public book until activation. The absence of a visible order therefore does not mean that potential future flow is absent. Equally, a drawn line does not prove that a particular participant's stops are there.

A false breakout as a testable event

Instead of saying "stop hunting", define a rule: price moves above the high of the last N closed candles and closes back below it within K candles. Specify whether entry on the returning candle itself is allowed and which price is realistically available after that candle closes.

For example, N = 20, K = 2, source: trades in one contract, interval: 15m. The level is already known when it is crossed. After a return, the plan permits observing a short, but does not declare a subsequent decline inevitable. N and K are illustrative, not optimised for returns.

If confirmation requires a close, entering retrospectively at the same candle's high is invalid. An earlier limit entry is a separate hypothesis with its own statistics. Keep cases without a return and cases where the breakout continues in the test.

Execution near extremes

News and liquidation cascades can widen spreads and slippage. A stop slightly beyond a common level does not guarantee protection from a "sweep". A wider stop with the same quantity increases the money loss.

Example. Budget R = 10, entry 100 and stop 101 give short q = 10 before costs. If a newly justified stop is 102, quantity must become 5 for the same R. Keeping q = 10 doubles planned risk. Moving the line does not, by itself, make a trade more robust.

Exercise. Find ten moves beyond a preselected level. Mark continuations and returns separately. In the journal use "I observe" for facts and "I assume" for motives. Explain what additional information the order book and trade data could provide, and what even those data cannot prove.