The concept of Order Block (OB for short) is very popular in financial market trading. The better the liquidity, the more powerful its function is. Therefore, the influence of order blocks is very significant in the foreign exchange market. In today’s article, I will lead you to understand order blocks by answering the following questions:
What is an order block?
An order block refers to the first reverse candlestick before a certain trend begins: if it is an upward trend, then the order block is the last negative candlestick before the upward trend begins; if it is a downward trend, the order block is the last positive candlestick before the downward trend begins.
It can be seen from this that the order block is not a forward-looking indicator like engulfing or piercing. It can only be identified after a certain market trend has emerged. But it still has a very important role in trading.
The following is the daily chart of EURUSD. The areas represented by the two candlesticks in the chart can be called order blocks.
What is the logic behind the order block?
The logic behind the order block (all the following takes a bullish order block as an example): To reduce the impact cost, when large investors build positions, they will not buy in one go. Instead, they divide a large order into multiple small orders and enter the market in batches. As the short orders in the market are exhausted, the price starts a new round of upward trend.
After learning about the order block, let’s reveal the core significance of the order block: strong support and the opportunity for a second entry.
The reason is very simple: after the upward trend has been running for a period of time, the bulls may take profits and the price will then have a pullback. But when the price falls back to near the order block, the trend may change. Because the price has returned to the cost of the institutional holders, the institutional profit-taking will stop for a while. At the same time, if new shorts get involved, in order to prevent themselves from having floating losses, the institutions will also defend their cost price.
Of course, not all OBs (order blocks) are unbreakable because all supports will be broken one day. Once the OB area is lost, it means that the institutions that were originally long may have changed their positions, the support turns into resistance, and the OB becomes a breaker block (BB for short).
The usage of the breaker block is similar to that of IFVG, so we won’t go into more details here. Here we mainly focus on exploring how to identify effective order blocks. After an effective order block is broken, it naturally becomes an effective breaker block.
Logically speaking, order blocks are manifested in two forms on the chart: first, a relatively obvious engulfing trend, that is, large negative and positive candlesticks are interlaced; second, a positive candlestick suddenly appears after a series of small negative candlesticks. But these two points seem to be still not complete enough. Because it only takes into account the candlestick patterns without considering the wave band or trend.
Through long-term trading practice and review, I have summarized the following three points:
First, the positive candlestick after the occurrence of the order block must be a trend candlestick with sufficient strength (the entity accounts for more than 50% of the entire candlestick). Theoretically, only if the subsequent rebound is strong enough can it indicate that the short orders in the short term have been exhausted. If the subsequent rebound is weak, it means that the institution’s long orders are scattered and not concentrated enough.
Second, it is accompanied by the appearance of FVG. The appearance of FVG further verifies that the short orders have been exhausted and the market has reached a state of imbalance between bulls and bears.
Third, the upward trend after the appearance of the bullish order block must trigger a structure breakout (SB for short). This sentence is easy to understand. For example, a higher high pattern appears in the upward trend (left side of the following figure), or the downward trend turns into an upward trend (right side of the following figure).
First, for investors who want to be more conservative, they can consider going long after the price retraces to the OB or FVG area and a reversal pattern appears. In other words, we can regard OB and FVG as tools for judging whether the position where the reversal pattern appears is reasonable. This is also a core idea in my personal trading system: SMC + price behavior.
Second, don’t focus on too small time frames, such as those below the 1-hour chart. Because institutional investors seldom engage in intraday scalping trading, they seldom or almost never make decisions based on 1-minute or 5-minute charts.
Third, like FVG, OB gives us signals indicating some future price pullback target prices and allows us to return to the original trend. Its advantage is that we can formulate many trading strategies with high profit-loss ratios by using OB. But the disadvantage is that very often the price pullback may not reach these targets. In other words, patience is very important.
Finally, it should be noted that before the price retraces to OB or FVG, there may be a situation of obtaining liquidity in a smaller time frame. If there is a situation of obtaining liquidity, then we can be more confident that the price will rebound.
Reproduction Notes：InvestFancy » What Is an Order Block?