Lecture Notes: Reinforcing Order Block Theory - Vacuum Block

Introduction to Vacuum Block Theory

• Definition: A bullish vacuum block is a gap in price action due to a volatility event, creating a vacuum of liquidity.
• Causes: Events like non-farm payroll releases or geopolitical events can cause vacuum blocks, particularly in futures or stocks with session opens and closes.

Understanding Gaps in Market

• Market Rally & Exhaustion:
  • If the market has been in an uptrend and gaps, it might indicate exhaustion (capitulation).
  • In a downward correction within an upward trend, a gap may signal bullish news or liquidity reach.
• Trader Assumptions:
  • Initial assumption is a continuation of the gap direction, but analysis of vacuum block can give insights into potential market directions.

Identifying and Analyzing Vacuum Blocks

• Diagram Setup:
  • Short-term lows and market rallies before a gap indicate where the vacuum block may form.
• Candlestick Analysis:
  • The gap is identified between previous candle's close and next candle's opening.
  • Lack of trading between these points creates a liquidity vacuum.
• Market Expectations:
  • The market often attempts to close the gap, but identification of gaps is crucial.

Trading Strategies with Vacuum Blocks

• Bullish Setup:
  • Look for bullish order block or down candle that prevents the gap from filling completely.
  • Price trading into the down candle may signal a potential buy opportunity.
  • Define risk using stop-loss below the lowest down candle.
• Consider Time of Day:
  • Time-sensitive gaps may not fill completely, especially if created late in the trading session.
  • Earlier gaps during active trading sessions are more likely to fill.

Trading Insights and Risk Management

• Full Gap Closure:
  • Indicates balanced price delivery and allows for bullish trades post-closure.
  • Buying at the gap closure can define risk and leverage.

Summary of Vacuum Block Theory

• Breakaway Gap:
  • Creates a liquidity vacuum and not all gaps fill completely.
  • Bullish order blocks may prevent complete gap filling, leaving a fair value gap.
• Price Behavior Post-Gap:
  • Efficient price delivery should not see price revisiting below the first up candle post-gap.
  • If prices trade down post-gap completion, re-evaluate the position.

Practical Application

• Understanding the dynamics of vacuum blocks helps anticipate market movements and manage trades effectively.
• Reverse application applies to bearish scenarios with gaps closing on up candles and short positions taken subsequently.