Trading the clearout
Updated: Sep 30, 2019
Before diving into trading the clearout, lets break down some basics of why this pattern exists and how liquidity is positioned around the clearout price structure.
Price generally moves from structure to structure squeezing one side of market most of the time, liquidation events are constant processes that move markets intra-day.
The larger the liquidity fuel zone buildup, the more likely it is to be targeted by market maker, especially if it is counter trend structural setup. Often clearouts will form against main trend, for example an extended bearish trend, structural consolidation and then clearout of lows and complete reversal upwards from there, that is how the clearout is initiated (and vice versa for bearish setup). This is often common in very liquid markets such as FX or large cap equities that trade on strong volume. In small cap equities and crypto, clearout is often formed against majority of retail volume participation which is respective to the short side for first market and long side for second market, but the main rule still applies that large portion of those clearouts will be formed against overall trend direction.
Bellow is conceptual presentation of how liquidity is often positioned around structures in market. Bellow example is especially true for very symmetric / consolidated price structures, where large amount of traders will use same price levels to place their entries or exits at, but more frequently the exits or stop losses.
In order to understand why market maker might trigger liquidation / clearout intentionally, it is important to understand the above concept of fuel zones. This is not a conspiracy theory in any sort, it is simply the means of how larger players might want to use high liquidity zones to put their own large orders in without having too much impact on the price. Larger players often cannot trade the same as retail trader does, because in low liquidity areas they might push price and have bad overall average on fills, or have to fill large amount of orders with market orders since there is not enough limit book liquidity to fill them in. But that is not always the case as some market making activity is actually created with intention to push the price, both sides of the coin are present.
One very important concept to note for clearout play is consistency of symmetry, by far the most important concept when it comes to clearout. Majority of targeted clearouts will happen around structures where price is consistently bouncing from demand / support level or resistance / supply level, thus trader should only focus on such structures to identify and trade clearouts. The more bounces in structure, the better.
This is especially true for symmetric clearouts in crypto and FX, while in small cap equities it applies a bit different with more asymmetry.
Also should be noted that clearout is just a micro play, there should be additional variables stacked before trader should consider trading it. For example using catalysts in Forex, usually best A grade clearouts will be ahead of PMI/CB/NFP news where MM will remove certain liquidity to fill his orders ahead of news into clearout. Or in small cap stocks it might be when stock is trading on heavy volume and is manipulated, those sort of variables should be additionally stacked before considering trading micro play of clearout.
Limit order stacks, stop losses and breakout orders
Conceptual presentation of limit order liquidity bellow and the impact of structural symmetry / consolidation on it. As the time passes and price is unable to significantly break dense highs or lows chances are the liquidity around those price levels will increase with time. The more time it passes the more the liquidity will increase (if major highs / lows do not break), the more juice for MM (market maker) to push for clearout liquidation.
Clearout is liquidation event where the stop losses of buyers or sellers are taken out and the breakout traders are trapped in. Clearout and stuff both are similar concepts but stuff can happen around any price or no structure at all, while clearout will 90% of time happen around dense price structures only (multiple bounces with dense supply or demand). If big buyer wants to fill in size without slippage and large price impact, then that might be done where other buyers are liquidated and cleared out of positions so that they turn into sellers (long trader when exits position turns into selling long order) which allows large buyer to swallow up their sell orders and fill long with minimal price impact (or the other side for short selling clearout on cover liquidation). Clearouts are most common around very clean symmetrical structures where many traders will watch the same price level or place SLs (stop losses) around the same price level. Therefore a huge buyer or seller would want to see that level broken for liquidation event to happen and push his position in while liquidation is taking place and absorb / fill into opposite orders.
Bellow is conceptual example of how often liquidity is positioned around structure where MM triggers clearout, it does not however mean that in every random structure with few bounces that is how liquidity will position. Bellow is only present on the structures with clearout, often.
For retail trader aim should be, to spot such potential plays and join the game of MM (market maker). Clearout should always present itself with very quick strong reversal move after critical lows / highs get taken out. Basically very quick rotation of price back into the structural support. The speed of rotation back will usually depend on market. In rigged microfloat stocks the rotation back might take 10-15 minutes as MM rigger needs to collect as many covers as possible over time, while in FX or crypto the rotations will be much quicker on average (1-3 min). If structure is not even on highs or lows positioning (for example highs or lows being connected to trendline instead of flat line) then the main area to watch is lowest low or highest high of structure, that is where majority of condensed SLs will sit and where breakout traders might initiate.
Example bellow in difference of flat vs trendlined positioning of lows and the importance of deepest low (LOD).
Bellow difference between targeted and non-targeted clearout (triggered by market maker or triggered by overall market action of weakness):
Small cap stocks
Majority of clearout examples on this article are for long side (crypto and FX and large cap equities) as a part of symmetric clearout, for small cap equities clearout is explained for specific Type 1 and Type 4 short trap under article of "Short traps on rigged stocks". But non the less the main variables and rules are all the same, just the trap is not set for shorts instead it is set for longs.
Clearout liquidations are present across many markets, but especially common in the most liquid markets, such as FX currencies, large cap equities (MSFT, NFLX, AMZN...) , microfloat stocks and Bitcoin.
After clearout candle under all structural lows or above highs, the price should start rotating back inside structure relatively quickly. Timing is the key, it should not take more than 10 M1 candles for price to rotate back above support (if its M1 structural pattern). This on average, it depends a lot on how big the structure is, how many candles are in each leg of structure, the more candles per leg, the longer it might take for clearout reversal move to happen, but it should not be more than 10 candles. On best plays it happens within first 3 M1 candles.
In order to trade those plays, trader needs a solid routine to find the patterns and have alert using methodology to support the searching process. Without use of price alerts and without knowing ahead what to look for it will be hard to make profits from those patterns.
Once potential symmetric structure is spotted (with variables that fit potential clearout attempt), trader should place alert bellow the structural lows (or above highs depending if its bull or bear pattern). This is critical as once alert is placed generally trader can take eyes of asset and only pop them back once the alert rings and price clears the required liquidity area, at which it could become potential clearout play. Using alerts is critical to minimize the requirements of watching the asset (basically less screen time) and to be more patient and "fresh" as trader.
2. Tape / order book / Bookmap / volume
The key to focus on is volume. At the clearout area there should be significant volume traded. For FX, using futures volume data should be used, while for equities all platforms or brokers are equipped with real volume data.
For crypto Binance is very good, because there are many large sized traders using it, which provides reliable volume prints compared to overall market.
Bellow conceptual example of where very high volume should be traded on clearout.
Targeted clearout in bullish structure (FX and large caps)
Above is conceptual presentation of the first type of clearout pattern and its structural composition, bellow are two examples of structural clearout with higher (or even) lows and higher highs in the structure. Drop into the lows will usually be initiated by market maker with heavy market order that will remove liquidity on bid side and swipe price under lows, liquidating stop losses of buyers. To trade this pattern on Forex the futures data is almost a must to use for quality volume data. Only on futures volume there will be clearly presence of high volume clearout, on spot FX it is often not visible, since FX only uses ticking volume. For entry, trader should wait for clearout liquidation and then for price to start curling back above support for long entry. Risk should be the lowest low of clearout break-down. But for traders who can read Level 2 orderflow well, there are many different better low risk combinations to handle the risk on play with smaller stop loss.
The key is to know which setup to pick and which to remove from play, the key being in targeted move. There are two variables that would qualify as valid play (either of them alone or both together):
1.Targeted quick strong move (1 or 2 M1 candles for example) from the middle of structure into the LOD or HOD.
2.Slower move with very high volume under the lows (SL clearout).
To access futures volume data (default volume indicator) one can subscribe to any broker providing futures data . That way if trader trades for example EURUSD in FX then E6 futures data can be used for futures volume prints.
Bellow are some examples with futures volume data confirming the clearout (currency futures). On both examples price rotated back into support and above within 3 M1 candles. It helps a lot to watch tape / level 2 at the clearout if there are large bulked orders coming trough chances are larger player is filling into liquidation (good for confirmation on entry.
Often large players will use clearout liquidations to rotate trends , as clearout area allows them to fill as much initial orders at best possible price and then further pushing with market orders to form trend rotation. That is why often price will break lows, then rotate, and then also break the highs in same structure and rotate downtrend into up trend.
Bellow is conceptual presentation of trend rotation with clearout climax:
Non targeted clearouts
Whole focus of trader should be to trade only targeted clearouts, those where market maker initiates them, and not the ones where general soft market action over time with weakness stops out the buyers, since many of non targeted clearouts do not rotate back.
The key component for trading the clearout is that it has to reclaim the support for long play (or resistance for short play). If it does not reclaim it is unlikely to rotate the price.
Bellow is example with high volume clearout under lows as the longs are stopped out, but it did not reclaim the support level, thus not a long play. It was not targeted attempt.
A grade clearout in crypto
Bellow is A grade setup in crypto. As Mike Bellafiore said it: Proper trading setup needs variables , the more the better. A grade play clearout on crypto will consist of those variables:
-heavy wash ahead of structure
-symmetrically clean structure with even lows (ensuring even SL positioning under them)
-very high volume on clearout, highest volume candle in whole structure
-structure with progressive lower highs
-volatility on asset will be high (dense structure on liquidity)
-sharp and quick reversal on single M1 clearout candle
-catalyst with heavy wash result ahead of structure
The amount of volume traded on clearout candle does not matter in terms of size of contracts, it only matters in relevancy to the structure. The volume should be a lot higher than average traded volume inside structure. One could say what matters is relative volume, because sometimes good clearout play could trade on 30 Bitcoin clearout volume, while other can be at 300 Bitcoins liquidated and traded, it all depends on current average liquidity.
Usually the main juice of liquidity will be under the most southern / lowest low of the structure, that is where most traders will put stop loss orders, because of the psychological effect of being "the safest place" as offers need to work harder to get that liquidity as oppose to putting order under the highest lower low. Market makers / whales know this and thus target those zones, 90% of clearouts will go straight trough the lowest low in the structure.
Bellow is B qrade example. Not a targeted clearout, those should be avoided for trading as there is no decent statistical chance of rotation after.
Clearout is specific pattern that happens usually only in highly liquid markets. The market type (FX, equities..etc) does not matter, it only matters the liquidity on that day that is trading. For example those plays could be never present on small cap equities for 99% of time, but then on the day that small cap asset trades massive volume this pattern might be present, as it presents opportunity for market maker. Same with alternative crypto coins, it will not be present 99% of time, until the day arrives and asset trades on massive volume and that is when the pattern might emerge. While on assets that trade very high liquidity every day such as Bitcoin this pattern will be frequent and consistently present.
The faster the price reclaims support and pushed above after the clearout, the better play potentially it is. On A grade plays, price should reclaim support within 1-3 M1 candles after clearout. Bellow is B grade example, but it had quick reclaim after decent offers were soaked by buyer.
The volume prints on each candle will reveal when the longs will start to panic, or where the actual stop losses are positioned, thus being patient and waiting for that high volume is key, and watching speed of tape when offers start to flush big time but the price actually starts to move up.
If structure is not symmetric (evenly positioned lows) it is hard to base the entry, that is why structure should be clean and symmetric. This allows precise entry conditions across all plays and use of alerts to help with coordinating the entry. Bellow is example of asymmetric structure and clearout.
The deepest lower low (often LOD) is the main play area that trader should wait for. Example bellow.
Bellow is another example of A grade play, with very consistent and symmetric structure on demand level. Dip under lows for clearout and then fast rotation. This is the kind of play to add heavier size on position. Often A grade clearouts will form bottom on asset and allow trader to scale for larger profit targets. Often people in crypto say what is the best way to buy crypto on dips and the circulating answer is "dollar average in every month", which is true for quickest and least time consuming way to go about it. But if trader / investor really wants precision and accuracy with controled risk , then the best way to go about it is waiting for A grade clearout and only buying there while looking for large run after clearout. It will not happen every time, it might happen only on 20% cases, but the risk to reward is very good for the plays that eventually do work out. This pattern also works out well for very liquid equities (high cap) and FX assets under major macro flows. Bellow bottoming example on Bitcoin after clearout.
To anticipate the pattern it helps to focus on assets that are "at play". Usually assets that have fresh catalysts on them, or very hot markets such as crypto when strong bull market is in phase. For example when crpyo markets pick new bullish trend , trader should focus on searching for clearout patterns. Clearouts are very frequent in crypto markets because strong trending market attracts many un-experianced traders who step into margin trading, usually buying around the lows, and since they are unaware of trap it is relatively easy for market maker to replaying the pattern over and over again, stopping the long traders out with clearout under lows or stuffing the clean breakout.
Clearout on microfloat stock
Bellow is conceptual example of clearout on rigged microfloat stock. After HOD is taken out often rigger will unload big size as all the liquidity is already collected. Type 1 short trap. The premise of this type of clearout is to potentially trade it short after HOD is cleared (if price starts to form microshelf and does not push any higher).
Bellow example of clearout on short side for microflaot stock. Again the size of volume on clearout is not some default number, it matters relative to all the variables in context.
This clearout is more specifically explained on article of "Short traps" under Type 1 short trap.
Heavy whale washes on crypto, asymmetric clearout
This pattern is specific mostly to crypto markets. Whales often force those liquidations in very strong bull markets where whale will flush large bulked market order on major exchanges ( 500 or 1000 BTC in bulk orders) with aim to crush the liquidity and form strong wash.
The main goal might be to let all chasing margin longs sell out so that whale can load back his size at better lower average as the longs panic sell into large drop. This is constant practice in crypto markets, especially in the liquid coins and for some reason is actually legal, however there have been cases where it has been prosecuted.
Those whale washes can be extremely aggressive, pushing price 10-30% on coin within few minutes.
As margin crypto trader i believe use of stop losses is almost a must due to that, and the fact that often surprising catalyst hit crypto markets very often.
Examples on Bitcoin bellow:
This pattern is much harder to anticipate because there is no real structure of price or specific time to anticipate the pattern. From my own research on this patterns, the only variable i found to be present in majority of them is very strong bull market, but since this variable is so general and non-specific it does not help much. Often this pattern will develop along symmetric support / demand levels or after very strong parabolic bullish rallies.
Using emergency stop loss with 1-2% offset is a good practice, since there is no real specific variable to predict the pattern, even watching the tape does not help because those patterns emerge on surprising and quick market orders that crush the liquidity, giving trader no time to prepare ahead.
Personally my view is that the use of hard stops (MKT stop orders) should be defined upon which market trader trades. In some markets it is fine not using them, while other markets are almost a must to use. In crypto if one is leveraged/ margin trader with more than 1:10 leverage then SLs should be used. Otherwise its just matter of time when one get caught with pants down in big 1 or 2k Bitcoin washout.
Orderflow example for targeted clearout on crypto
To break it down in stages why clearouts are so frequent in crypto markets and why market makers set them and putting it trough variables. Not all clearouts are targeted by market maker it could just be that market as a whole puts price there, but the focus of this article is on targeted attempts that can be revealed trough specific price action , tape, size of offers and volume. The liquidity target of MM on clearout are mostly margin / leverage based traders in crypto since those are forced to cover / sell much sooner than the rest of crypto investors.
Bellow conceptual example, bull legs represent macro trends (2000-4000 USD moves on BTC), choppier consolidations represent micros from M5 time frames (size of 50-100 USD).
1.Strong bull market
First major component of what increases chances of targeted clearout on crypto is strong bull market. Once Bitcoin pushes for example from 6000 to 11000 it starts to attract a lot of new margin traders, who are mostly long biased. The data from exchanges shows that in each new strong bullish phase there will be large influx of long biased traders who are new to the game and usually only long. And since majority of those traders will use LOD or lowest current low to set stop loss or to exit, it creates predictable outcome for MM to set a trap.
2.Strong washout, then consolidation where MM starts to absorb / buy.
After initial strong wash ahead of structure, MM might start to absorb some size by buying. It might or it might just hold size from before higher average, this is just a guess there is no real way to prove this concept, but the main point is that MM should have some sized long position so that he can flush it and create the targeted liquidiation of other long traders under the lows of structure.
3.Symmetric bounces from lows
Once the symmetry starts to build up with even lows or higher lows many long margin traders will also start to participate in expectations that this might be bottom. The more symmetric the structure the more will use breach of lows as stop-out.
4.Clearout and reverse
Last part where MM will flush heavy sell market orders (seen on tape) in order to destroy bid liquidity and push price under lows. Usually once the lows are taken out huge selling liquidity will hit the tape but at same time also buying as the MM is trying to fill into offers. Best asset to watch tape around this part will be ETH, assets like XRP that have too high supply of overall coins are harder to read on tape around clearout levels. The lower the supply of asset the easier it will be to read the tape, or to say more meaningful each order passed on tape will be.
Basic principle of targeted clearout is the participation of retailers strongly on certain side of market, which MM will hunt to liquidate. Example bellow on long (crypto) and short (small cap stocks) side.