Introduction
Do you ever have the feeling of being the constant target of “smart money stop orders hunting”?
Well, you are not alone, and the answer more and more traders are pointing to is ICT concepts.
The Inner Circle Trading philosophy has created what is now grown to become one of the most popular trading strategies around.
Unlike more traditional strategies, ICT disregards any momentum or trend indicators (other than those directly derived by price action), focusing instead solely on price action. It was originally created by Michael Huddleston to trade the Forex market but traders are using the same strategies to make profit in all and any market they trade.
In this article, we’ll explore the seven most important concepts this trading philosophy is based upon so that you, as a trader, can evaluate its potential.
ICT. If you haven’t heard of it before, you have now.
Let’s go!
The ICT Methodology
The ICT methodology relies on chart technical analysis and is based on the belief that – by analyzing price action, levels of support and resistance, as well as order blocks – it is possible, in some measure, to identify the specific areas with the greatest concentration of liquidity and therefore, to predict new trends.
ICT methodology and techniques mostly rest on seven key concepts: Liquidity, Displacement, Market Structure Shift, Inducement, Fair Value Gap, Optimal Trade Entry, and Balanced Price Range.
Let’s now take a look at each of these concepts.
Liquidity
The first and certainly most fundamental concept in the ICT trading methodology is liquidity.
Liquidity comes in two forms: buy-side and sell-side.
The area on the chart where short-selling traders are most likely to place their stop orders is identified as the Buy-Side Liquidity. On the other hand, the opposite is also true of Sell-Side Liquidity which identifies an area where the bullish traders’ stop orders are instead concentrated.
Both the Buy-side and the Sell-side Liquidity are normally found towards the extreme of price volatility ranges – near the tops and bottoms of price patterns – because this, usually, is where most retail traders set their stop-loss orders or decide to close their positions.
The liquidity concept is the most vital part of the ICT methodology because – maybe somewhat more than the others, it attempts to mimic Smart Money’s trading behavior.
By setting their orders at levels with a high number of Retail Traders’ stop-loss orders, Smart Money has a higher probability of getting its orders fulfilled. And being able to predict what Smart Money is going to do next, gives ICT traders an insight into the upcoming trend.
Displacement
Displacement is a strong and sudden move in price either up or down that, on a chart, normally appears as a group of consecutive long candles with small wicks moving in the same direction.
There are two important things to remember about Displacement, according to ICT. The first is that a Displacement usually represents a sudden but powerful increase in buying or selling pressure and that this often occurs when price has reached a Liquidity level.
The second is that a Displacement almost always causes the creation of two things: a Market Structure Shift and a Fair Value Gap.
Market Structure Shift
By “Market Structure Shift”, ICT traders refer to the point on a chart where the current trend is broken. In other words, it’s the lowest point of a lower low after a series of higher highs and higher lows (in a bullish trend) or the highest point of a higher high that follows a series of lower lows and lower highs.
ICT traders see a Market Structure Shift as the first indicator of a trend change and, if this is confirmed, will often use this point in the chart as the base for their trades.
Inducement
Inducements are found at the extremes of mini-counter-trends within a larger-scale trend. ICT traders consider these movements to be caused by stop-loss hunting actions on lower time frames by – you guessed it – Smart Money.
ICT traders base their trades on the belief that once an Inducement level is reached and the extra liquidity has entered the market, price will then reverse again and continue on its original trend.
Fair Value Gap
More often than not, when a Liquidity level has been breached and the trend has reversed, we are presented with what appears as a “gap” on our charts and this is what ICT traders referred to as a Fair Value Gap.
More specifically, a Fair Value Gap comes in the form of a sequence of three candles with a larger one at the center and a gap between its wicks and those of the adjacent candles.
Fair Value Gaps have the tendency to get filled sometime in the future and this is the very concept ICT traders take advantage of when setting their orders.
Optimal Trade Entry
Once an Inducement has created a Displacement and this, in turn, has created a Market Structure Shift and a Fair Value Gap, ICT traders use Fibonacci levels to identify their Optimal Trade Entry point before executing their trades. Normally Optimal Trade Entry points are found between the 61.8% and 78.6% retracement of an expansion range.
Balanced Price Range
A Balance Price Range is a double Fair Value Gap created by two Displacements of opposite directions in a short period of time.
During a Balance Price Range price often oscillates in range testing and retesting the extremes in both directions in its attempt to fill both Fair Value Gaps. ICT traders aim to trade from this volatility as well as from the belief that price is likely to continue its original trend once the extremes of the Balance Price Range are breached.
Conclusion
The ICT methodology is becoming more and more popular because it seems to be able to give Retail Traders some of the advantages enjoyed by the hands and the minds behind Smart Money.
Remember
These are just seven of the most important ICT concepts; there is much more to learn about ICT as well as about stock trading in general. Keep researching, keep learning, keep following our blog, and keep bringing in those pips!
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