What is an Order Block?
An order block is a specific price range where significant institutional buying or selling has taken place. These blocks act as footprints left by large market participants, like banks and hedge funds, who have entered or exited positions. Recognizing order blocks on a chart allows traders to anticipate future price movements with greater accuracy.
Key Features of Order Blocks:
- Run on Liquidity: An order block often forms after price runs liquidity, such as breaking below a previous low or above a previous high, triggering stop orders.
- Candle Identification: Typically, the last up-close candle before a down move or the last down close candle before an up move is considered an order block.
- Price Rejection: When price revisits an order block, it often reacts strongly, indicating that institutions are protecting their positions or adding to them.
Types of Order Blocks
Understanding the different types of order blocks can help traders spot them across varying market conditions:
1. Bullish Order Block
A bullish order block is formed when the last down-close candle(s) precedes an upward move that breaks structure. It signifies that institutions accumulated buy positions before driving the market higher.
Key Characteristics:
- The price closes above the high of the down candle, confirming it as a bullish order block.
- The most sensitive area for re-entry is between the high and the mean threshold (50%) of the order block.
Example: Imagine a market consolidating at a support level. A final bearish candle sweeps below the recent low (collecting sell-side liquidity) and then reverses sharply upward. This last bearish candle becomes the bullish order block.
2. Bearish Order Block
A bearish order block is the inverse, where the last up-close candle(s) before a significant move down indicates that institutions were selling. It forms when the market drives lower after price has run liquidity and then retraced to fill orders.
Key Characteristics:
- The price closes below the low of the up-close candle, confirming it as a bearish order block.
- The area between the low and the mean threshold (50%) of the order block is where price is likely to react on revisits.
Example: In a market uptrend nearing resistance, a final bullish candle runs above a recent high(collecting buy-side liquidity) before sharply reversing downward. This up-close candle becomes a bearish order block.
Why Order Blocks are Important
Order blocks are significant for several reasons:
- Institutional Insights: They indicate where large players entered the market, giving clues to future price movements. Institutions often protect these zones or add to their positions when price returns to these areas.
- Dynamic Support and Resistance: Unlike traditional support and resistance levels, order blocks are rooted in actual market activity and represent areas where significant buying or selling interest exists.
- Strategic Entry and Exit Points: By using order blocks as a guide, traders can find high probability entry points with defined risk and targets.
How to Identify Order Blocks on a Chart
To spot an order block, follow these steps:
- Look for Price Structure Breaks: Identify areas where price breaks previous highs or lows.
- Find the Last Up/Down Candle Before the Break:
- For a bullish order block, find the last down-close candle before the upward move.
- For a bearish order block, locate the last up-close candle before the downward move.
- Mark the High and Low of the Order Block: Draw a box around the identified candle's high and low. This represents the range of the order block.
- Identify the Mean Threshold: Mark the 50% midpoint of the order block to pinpoint the most sensitive reaction level.
Trading Strategies Using Order Blocks
Here are some effective strategies that incorporate order blocks:
1. Reversal Trading
Order blocks are excellent tools for spotting potential reversals:
- Wait for price to sweep liquidity above or below a recent high/low.
- Identify the order block that caused the reversal.
- Enter a trade when price returns to the order block, using the mean threshold as a trigger point.
Example: If the market sweeps below a swing low, forming a bullish order block, a trader might place a buy order when price returns to the block, with a stop-loss just below its low.
2. Continuation Trading
Order blocks can also signal continuation patterns:
- Look for a retracement to an order block in the direction of the trend.
- Confirm that the broader market structure supports the trend (e.g., higher highs and higher lows for bullish conditions).
Example: In an uptrend, a bullish order block forms after a liquidity sweep. Traders can enter a long position when price retraces to the block, aligning with the existing trend.
Combining Order Blocks with Other Tools
For best results, use order blocks alongside other analysis tools:
- Fair Value Gaps (FVGs): An FVG near an order block enhances the likelihood of a strong price reaction.
- Killzones: Execute trades during high-volume periods, such as the New York Open, when price is more likely to react to order blocks.
- Higher Timeframe Analysis: Validate order blocks on higher timeframes to ensure they align with the overarching market trend.
Example of Trading with Order Blocks
Suppose a trader is analyzing EUR/USD and notices a significant bearish move that breaks structure and sweeps a previous high. The last up-close candle before the drop is marked as a bearish order block. Price retraces to this block, aligns with the broader downtrend, and volume increases as the market reacts to the block. The trader enters a short position at the order block’s mean threshold and places a stop-loss above its high.
Tips for Using Order Blocks Effectively\
- Patience is Key: Wait for price to reach the order block and confirm a reaction (e.g., with a rejection candle or volume spike).
- Manage Risk: Always use stop-loss orders to protect against unexpected price movements.
- Multiple Timeframe Analysis: Validate order blocks across different timeframes to filter out weaker setups.
Common Mistakes to Avoid
- Forcing the Setup: Not every candle preceding a strong move is an order block. Ensure that the identified block aligns with liquidity sweeps and structure breaks.
- Ignoring Market Context: An order block should align with the broader market narrative; otherwise, it may not hold when revisited.
- Neglecting Volume: Use volume analysis to confirm that an order block represents genuine institutional interest
Conclusion
Order blocks provide a deeper understanding of market behavior, moving beyond conventional support and resistance levels to reveal areas of significant institutional activity. Recognizing and trading order blocks can transform your approach, allowing you to enter and exit trades with confidence by aligning with the actions of smart money.
