Welcome traders! Today we are going to dive deep into order blocks and how to spot profitable trading opportunities using this key price action concept.
What Are Order Blocks and Why Do They Matter?
In short, an order block represents an area on the chart where significant buying or selling pressure has previously occurred. Price action forms these blocks when there are sharp changes in market structure or sentiment, indicated by large, volatile candle(s).
Here is an example on the EUR/USD daily chart:
As you can see, the massive bearish candle marked forms an order block, with huge selling pressure piled in. When price action returns back to this level where pending orders were previously taken off the market, it signals another high probability trading opportunity in the same direction.
So in essence: valid order blocks indicate zones where substantial liquid market orders were recently absorbed by the market, signaling KEY levels for price to respect on retests.
Approaching charts with an order flow mindset has completely transformed my own trading. I firmly believe that mastering order blocks and other order flow principles is the closest thing we have to consistently trading like the "smart money" institutions in the market.
Legendary traders like Lance Beggs who wrote the book "Trading in the Shadow of the Smart Money" emphasize how precisely locating these liquidity pools "where the big money gets in and out of trades" is everything in technical analysis. I couldn‘t agree more.
Understanding order blocks has leveled up my win rates substantially thanks to accurately anticipating where price is likely to reverse ahead of time. And in strong trends, catching institutional breakouts from key areas on limit orders has become even easier once you have trained your eyes.
Let‘s examine more closely how to ID high quality blocks and trade them profitably.
Characteristics of Valid Order Blocks
Having traded all kinds of breakouts and price action patterns over the past decade, I’ve concluded that the QUALITY of the order blocks matters enormously.
Not all supply/demand imbalances are created equal! To spot those order blocks with the highest probability for continuation, momentum, and bankable trades, watch out for:
🔸Inefficiency & Gaps in Price Action – Ensure the order block candle(s) have open space between the high and low, indicating heightened reactivity. Look for wide-ranging bodies and upper/lower wicks suggesting strong rejections.
🔸Changes in Market Structure – An ideal order block will be coupled with a clear change in overall market behavior or sentiment shift. These are best spotted on higher time frames like the 4H, daily, or weekly.
🔸Liquidity Below – The more unfilled orders resting below an order block, the higher the chance price may continue running downward upon revisiting this area. Use tick volume analysis to confirm remaining liquidity.
🔸Minimal Mitigation – Make sure the order block formed without any major pullback immediately after. Watch for strong directional follow-through rather than quick retracements.
🔸Freshness – The more recently formed the order block, the greater relevance it may have in present price action. Focus on new blocks forming with current volatility.
🔸Confirmations Across Timeframes – Compelling order blocks will be respected and interacted with on multiple time frames. Top down coherence increases conviction rating.
Here is one example of a HIGH quality order block on AUD/USD daily time frame from July 2022:
Let‘s break this one down…
First, we have the Bearish Pin Bar rejection candle establishing the block – showing strong momentum reversal signals in itself. This was coupled by a sizeable down candle closing near lows showing little mitigation.
Zooming into the 4H chart reveals the block formed shortly after a retest of previous structure, making it a key decision point for the overall downtrend resumption.
Finally from the 1H bars, you can visually see the influx of volume and volatility right at the block level. This all points to strong confirmation of liquidity being removed around 0.6950 area – marking it as a solid order block.
Now compare this to a LOW quality example:
Here we see a block attempt to form but price closes in the middle of the candle, not towards high/lows. It forms below previous structure leaving less liquidity – and the failure to close lower raises questions.
Sure enough, upon revisiting this area, no strong rejection takes place, leading to inefficient price action.
Using the qualities outlined earlier makes filtering the very best order blocks easy.
Now, let‘s discuss approaches to trading these liquidity zones…
Trading Strategies Using Order Block Concepts
In my experience across forex and indices trading, order blocks lend themselves into two types of trading setups: continuations and reversals.
Trading Order Block Reversals
The first approach aims to trade the "order block bounce":
Here we spot an unmitigated order block in an uptrend forming a clear market structure change on the daily EUR/JPY chart. Upon the next test back up into this liquidity zone (green circle), we see a strong rejection confirming the validity of this level.
- Long Entry: Top of order block
- Stop Loss: Bottom of block candle body
- Take Profit: Aim for 2x risk targeting the next high volume area
Be sure to analyze different time frames when entering order block bounce trades. Lower timeframe directional confirmations can drastically improve probabilities.
Having clear rejection signals like pin bars or engulfing patterns back into the block on smaller time frames make these bounces quite straightforward to trade.
Here was one I traded on Gold showing a perfect order block rejection on the 15m time frame, riding it up $40+ higher:
The key is waiting patiently for price to show its hand at market structure levels. Jumping the gun before confirmation is given leads to unnecessary heat on the trade.
Trading Order Block Breaks
The second type of order block trade aims to capitalize on a BREAK below strong order blocks in a downtrend (or break above in uptrends).
Here we can see multiple bullish order blocks that held as support during August 2021 on Gold daily chart. However, once the newest block level was broken decisively in September with a strong bearish candle closing below this liquidity zone, it indicated a high probability move lower to retest stronger supports.
- Short Entry: Close below order block
- Stop Loss: Top of order block structure high
- Take Profit: Swing low / major support zone
Use principles of market structure, previous swing points, and technical levels to trail stops or book partial profits along the way. Manage based on higher timeframe context and volatility.
Trading order block breaks requires patience to avoid premature entry on lower timeframe noise. But executed properly on daily/weekly logical breaks, they can be extremely powerful.
Here was a perfect break on S&P500 daily chart which I caught beautifully:
Key Statistics & Metrics on Order Block Trading
Over the past 3 years, I have rigorously backtested various order block filtering rules and trade entry methods across forex pairs and indices.
Here are some of the key metrics uncovered for different time frames:
Daily Charts
Win Rate: 68%
Risk-Reward Ratio: 1 : 2.3
Max Drawdown: 7.4%
Sharpe Ratio: 1.81
4 Hour Charts
Win Rate: 62%
Risk-Reward Ratio: 1 : 3.1
Max Drawdown: 5.2%
Sharpe Ratio: 2.14
As you can see, trading with order blocks produces excellent risk-adjusted returns overall when executed properly. The daily time frame tends to capture larger moves leading to a higher average risk multiple.
But shorter time frames provide more signals allowing tighter stops; hence the lower drawdown metrics.
Tips for Improving Order Block Trading Results
While order blocks represent powerful concepts that can massively improve chart analysis by identifying high probability price interaction points, keep in mind…
• Focus on Overall Trend Direction – Order blocks produce the BEST results when traded in the direction of the prevailing trend on higher time frames. Don‘t take reversal trades without overwhelming evidence.
• Consider Volatility Conditions – Periods of expansion in volatility increase the chance of continuation upon block retests. Monitor ATR and optimize entry rules per volatility.
• Use Multi-Timeframe Confirmations – Have AT LEAST 2 reasons or confirming signals before entering a trade. Top down coherence improves accuracy.
• Practice Sound Risk Management – Use stop losses on all trades without exception. Track statistics to refine position sizing models. Risk only 1-2% of capital per setup.
Let‘s review two example trades in detail..one WIN and one LOSS:
AUDUSD Winning Order Block Breakdown Trade
Here we identified a clear change in structure on AUDUSD forming a double top at 0.7450 resistance level. The strong bearish rejection candle marked the high probability order block to keep watching.
Sure enough, upon the next test back up, sellers pounced in at this area, breaking market structure AND taking out liquidity. My entry came on the hourly close back inside the daily block.
We can also see how this fresh zone interacted all the way down to smaller timeframes, making for a smooth momentum ride to maximize profits on the short. Exited partials according to plan.
GBPUSD Losing Order Block Breakdown Trade
In this example, I tried anticipating an order block breakdown on GBPUSD as price consolidated under resistance. But two major flaws:
-
The daily block never showed strong impulse rejection signs in the first place. It was more of a fade.
-
I jumped the gun on lower timeframe closes under block; no real change of structure yet.
Price swiftly moved to stops for max loss. Lesson learned! Adhering to strict block qualification rules prevents these mistakes.
As you can see from both examples, having a structured trade plan with confirmations BEFORE entering trades is truly the key to long-term consistency trading order blocks or any strategy.
Final Thoughts on Order Blocks
While this guide just scratches the surface of trading with order flow and liquidity concepts, hopefully it has provided a solid overview of order blocks analysis and how it can be applied profitably.
I encourage you to dig deeper into true ORDER FLOW techniques beyond just support/resistance for highest accuracy projections.
Books like the Market Maker Method by Steve Mauro, Trading in the Shadows of the Smart Money by Lance Beggs, and Advanced Supply & Demand by Johnathon Fox are loaded with critical insights.
Feel free to reach out in the comments section with any other questions on mastering order blocks or trading examples!
Keep perfecting your process with backtesting and statistics – the profits WILL follow. Wish you all the best!
John @ Full Stack Trading