Order blocks refer to specific price areas where large market participants such as institutional traders have previously placed significant buy or sell orders.

Clusters of orders are present in these areas which can have an impact on price movement, liquidity, and market sentiment. 

The concept of order blocks is a certain type of approach for identifying key levels of support and resistance based on the behavior of institutional traders. These key levels are then used as an entry or exit point for trades.

What is an order block?

An order block is an area where there has been a large concentration of limit orders waiting to be executed.

Order blocks are identified on a chart by observing previous price action and looking for areas where the price experienced significant movement or sudden changes in direction.

SPY Order Blocks

When trading price action, these areas, are important to watch as they can act as turning points, influencing the future direction of the market.

When a large number of buy or sell orders is concentrated in a particular price level (or zone), it can create a strong level of support or resistance. As the price approaches these levels, these large orders can absorb the buying or selling pressure, causing the price to reverse or consolidate.

Traders will often look for signs of whether that level will hold or fail.

Trading order blocks involve identifying these areas of significant buying or selling interest and using that information to make decisions about possible trade entries, exits, and risk management.

Why are order blocks important?

Order blocks can affect the market in several ways:

  • Price Movement: Due to the large size of these orders, order blocks can influence the market price. When a big block of buy orders is executed, it can push the price up, while when a big block of sell orders is executed, it can push the price down.
  • Liquidity: Order blocks can change how liquid a market is because they are often big enough to absorb all the available liquidity. This can result in temporary imbalances between supply and demand, causing price volatility.
  • Market Sentiment: Order blocks may signal the sentiment of large players in the market, who often have access to better information and are more informed Because of this, other traders will follow them, which drives up the price.

Overall, order blocks are an important concept in price action trading and can provide insights into the behavior of institutional traders and the key levels that are likely to impact the price of an asset in the future.

How to identify order blocks

Price action traders usually look at how prices have moved in the past on the chart to see where the market has reacted strongly. These reactions could be in the form of price reversals, consolidations, or breakouts.

Potential order blocks are marked at the price levels where these reactions happen.

Order blocks often act as support and resistance levels. If the price bounces off an order block more than once, it is seen as a strong level of support or resistance, depending on whether the price came from above or below.

The more times that price returns to the order block, the weaker it becomes as a support or resistance level.

When the price breaks through an order block level, the role of support or resistance reverses.

For example, a broken resistance level can turn into a support level and vice versa. When this happens, you might wait for a retest of the level that was broken before entering a trade in the direction of the breakout.

How to trade order blocks

Here’s a step-by-step guide to trading order blocks:

1. Identify order blocks

Analyze past price action on the chart to find areas where the market has shown a significant reaction, such as price reversals, consolidations, or breakouts. Mark these price levels as potential order blocks, which may act as support or resistance.

2. Observe price behavior

Watch how the price moves as it gets close to an order block. If the price keeps bouncing off the level, it means that it is a strong area of support or resistance. Keep in mind that the price may go above or below the exact level, so think of the order block as a zone instead of a precise level.

3. Trade entries

Look for two possible types of trade entries:

  1. Reversal trades: If the price approaches an order block and shows signs of a reversal, such as the formation of reversal candlestick patterns (e.g., shooting star, hammer, or engulfing patterns), you can consider entering a trade in the opposite direction of the trend, anticipating the price to bounce off the order block.
  2. Breakout and retest trades: If the price breaks above or below an order block, wait for a retest of the level, which may now act as support or resistance (depending on the breakout direction). Look for confirmation through candlestick patterns, price action, or other technical indicators before entering a trade in the direction of the breakout.

4. Look for confluence

To increase the probability of a successful trade outcome, you can combine order blocks with other technical analysis tools, such as trendlines, moving averages, Fibonacci levels, or chart patterns,

5. Set stop loss and profit targets

Place a stop loss order slightly beyond the order block to limit your risk of loss from unexpected price movements.

Set profit targets based on nearby support and resistance levels or by using a risk-reward ratio that suits your risk tolerance and personal trading approach.

6. Manage risk

The market may not always respect order block levels!

Always use appropriate position sizing and risk management to control your exposure. Keep your risk per trade consistent and avoid using too much leverage.

7. Monitor and adjust

Keep an eye on your trades and be prepared to tighten or trail your stop loss or adjust profit targets if the market conditions change. Stay disciplined and stick to your trading plan.

Like any trading strategy, trading order blocks is NOT a surefire trading method, Before trading this approach in a live trading environment, it is critical to practice and backtest it for yourself!