One of the most popular trading philosophies out there today is the ICT method. Short for Inner Circle Trader, and utilized by many in traders nowadays, this style of trading is mainly based on price action and incorporates little to no use of trend following or momentum indicators.In this teaching, we’ll go over the basic concepts of the ICT methodology so that you can begin to understand how to utilize it in your trading.
Key ICT Concepts
The ICT trading methodology consists of some key concepts that every trader must know in order to take advantage of trading in this style. In the sections below, we’ll discuss the key takeaways as well as show how to utilize some of these concepts.
Liquidity
Liquidity is the first, and arguably the most important concept within the ICT trading methodology. There are two types of liquidity; Buy-side and sell-side. Buy-side liquidity represents a level on the chart where short sellers will have their stop-loss positioned. Sell-side liquidity is just the opposite. It represents a level on the chart where long-biased traders will place their stop loss. In both cases, these levels are often found at or near extremes as the tops and bottoms of ranges are often viewed as areas where traders are ‘proven wrong’ and, therefore, will want to get out of their trades.
‘Smart money’ players understand the nature of this concept and commonly will accumulate or distribute positions near levels where many stops reside. It is, in part, the sheer amount of stops at key levels that allow a larger player to fully realize their position. Once the level at which many stops are placed has been traded through, it’s often that the price will reverse course and head in the opposite direction, seeking liquidity at the opposite extreme.
Displacement
Displacement, in short, is a very powerful move in price action resulting in strong selling or buying pressure. Generally speaking, displacement will appear as a single or a group of candles that are all positioned in the same direction. These candles typically have large real bodies and very short wicks, suggesting very little disagreement between buyers and sellers.
Often, a displacement will occur just after a liquidity level has been breached and will often result in the creation of both a Fair Value Gap and a Market Structure Shift.
Market Structure Shift
As many traders know, the basics of trend say that in an uptrend, the price is making higher highs and higher lows and in a downtrend, the price is making lower highs and lower lows. A market structure shift is represented by a level on the chart where the previous trend is broken. If the price is in an uptrend, the market structure shift level is where a lower low is made. If the price is in a downtrend, the market structure shift level is generally going to be at a point where a higher high is made. In both cases, market structure shifts tend to occur on the heels of a displacement.
Once the price has traded through a market structure shift level, a savvy trader will begin to look for further signs that the trend has, in fact, changed, using the market structure shift level as a level to trade off of.
Inducement
Rarely does the price move in a straight line. Within a larger trend, there are almost always counter-trend moves. These counter-trend moves are the results of lower time frame liquidity hunting. The price will bounce or get rejected and then will target a previous short-term high or low before continuing in the same direction as the longer-term trend. Inducement is specifically the targeting of these short-term highs or lows as areas where stops might be placed.
As we know, liquidity lies where an influx of stops are located, and once those stops are taken out, the price can continue in the direction it was previously going. For traders who are used to utilizing chart patterns, Inducement can be seen in the formation of bull and bear flags.
Fair Value Gap
After the price reaches a liquidity level and then reverses, what will often come next is Displacement. Fair Value Gaps are created within this displacement and are defined as instances in which there are inefficiencies, or imbalances, in the market. These imbalances are visualized on the chart by a three-candle sequence containing one large middle candle whose bordering candles’ upper and lower wicks do not overlap.
Many traders are interested in Fair Value Gaps because they can become magnets for price in future price action.
Optimal Trade Entry
Optimal Trade Entries are just that; They represent the best places to get into a trade and they can be identified by utilizing the Fibonacci drawing tool. In most cases, an optimal trade entry will lie somewhere between the 61.8% and 78.6% retracement of an expansion range.
After a Market Structure Shift occurs and a new leg of price action is formed, the bounce that follows the new leg will often yield an opportunity to take a position in the direction of the new leg and these Fibonacci retracement levels can be used to identify where that position should be taken.
Balanced Price Range
A Balanced Price Range is the result of an aggressive move up that’s immediately followed by an aggressive move down or an aggressive move down that’s immediately followed by an aggressive move up. What’s left after either of these instances is essentially a double Fair Value Gap which can act as a magnet to the price before a continuation move higher or lower.
Balanced Price Ranges can sometimes signal the beginning of a Market Structure Shift, and the price can often retest and reject from these areas.