What Is Order Flow Trading
Violet Mcdow
Order flow trading is a type of trading strategy and form of analysis used by traders on the markets, other popular forms of market/trading analysis include technical analysis, sentiment analysis and fundamental analysis.[1]
Order flow trading is the process of analysing the flow of trades being placed by other traders on a specific market.[2] This is done by watching the Order Book and also footprint charts.[2] Order flow analysis allows traders to see what type of orders are being placed at a certain time in the market, e.g. the amount of Buy and Sell orders at a given price point.[3] Traders can use Order Flow analysis to see the subsequent impact on the price of the market by these orders and therefore make predictions on the future price and direction of the market. Order flow trading is a type of short term trading strategy as it is used to enter the market accurately based on recent executed buy and sell orders.[2] Order Flow Trading is sometimes referred to as a form of volume trading.[2]
The numbers on the left hand side of a footprint candle show the volume/amount of sell orders executed, the numbers on the right side of a footprint candle show the volume/amount of buy orders executed, footprint candles are read diagonally up, and to the right. E.g. a sell order on the left hand side is compared with a buy order one tick up, diagonally to the right of it.[4]
Order Flow analysis shows the volume of Buyers and Sellers at a specific price point and at a given time, it can also show the accumulation of orders waiting to be executed at different price levels. On candlestick charts this is shown more broadly by individual candlesticks, however, Order Books and footprint charts show the individual buy and sell orders placed within these candlesticks and therefore give a deeper view on the micro price movements. Order Flow traders can see both Limit orders and Market orders being placed, footprint charts show only executed market orders and therefore show the actual volume of buyers and sellers.[5] limit orders are price points where traders have ordered to buy or sell a stock, these orders will not get executed unless the price of the market hits their limit order price point.[6][7] These orders are not shown on candlesticks charts and can only be seen on Order Books, once these orders have been executed they turn to Market orders which are then displayed on the chart.[8]
Order Flow Traders can see levels of support and resistance by the size of buy and sell orders. On a footprint chart these are shown by buy and sell imbalances.[4] A buy imbalance tells us that there are much more buyers than sellers at that price point, indicating potential support levels. A sell imbalance shows that there are a lot more sellers than buyers at that price point and this can indicate a potential resistance point.[9] The volume of buyers and sellers is also used to indicate potential trend reversals and is a strategy that some order flow traders will apply to footprint charts.[4]
Spoof orders or Spoofing are when traders will place orders at certain price points and then cancel these orders just before they are executed, they are used to deceive other trades into analysing false support and resistance levels.[10]
The many different types of financial data play a vital role in attempting to predict market trends. But just as there are many types of information in the form of market data, there are also many different ways of analysing them.
Definition of Technical Analysis (TA): Technical analysis is a technique that utilizes historical market data to identify and predict trends. Using simple price and volume traded data to analyse historical prices movements, TA attempts to find recurring patterns that will repeat in the future.
Definition of Order Flow: Order flow Analysis is a technique used to anticipate changes in price in the market by observing the flow of constantly changing orders of various sizes (liquidity) and the aggressive trades (transactions) to view their impact on the market price. This analysis allows the trader to observe the balance between different market players as they bull and sell, and is the fundamental building block of market mechanics.
Pros of TA: Technical Analysis provides traders with a way to digest price information in a way that makes making a trade more defined. It allows them to look at historical and current trends in a more analytical way.
Timing plays a crucial role in trading, and having a predefined way to exit or enter the market makes trading easier. Technical analysis can anticipate when a trend may reverse, which helps traders make market decisions.
Cons of TA: Technical Analysis does not take into consideration other financial data such as the economic and financial factors that can influence the market. However, some traders consider this to be a positive, since they believe that all forms of fundamental news should be baked into the price.
But technical analysis can also be overly complicated, making many traders confused by mixed buy and sell signals. Therefore a detailed plan and a deep understanding of TA signals is vital before taking a trade.
Order flow also often uses historical data to anticipate prices, just like technical analysis. However, it is much more immediate as good order flow analysis will track the finer details of price, such as volume, as well as the quantity and size of both the purchase side and the sell-side of the market.
Trading in financial markets involves risks and is a game of probabilities. The purpose of any form of analysis is to provide the trader with accurate information based on historical trends in the market and hopefully a better chance of making a profit. However, this does not guarantee results, since there are still some elements of the markets that are random.
Looking beyond price and understanding liquidity and its behaviours can help you dive deeper into the market and make informed decisions. Success or failure ultimately depends on the individual trader, the quality of their analysis, how efficiently they carry out the execution of their analysis.
Bookmap was developed for, and by, order flow traders. The array of tools and indicators available, as well as the quality of education available, can make you a better trader just as long as you have the right mind-set! You can try it out today for free. Click here to get started.
Trading chart patterns formed by the historical movement of prices and put repeating price behaviours into a visual pattern. These patterns act as the basis of technical analysis and allow the trader to find entry and exit points, as well as better manage their risk.
RISK DISCLOSURE: Trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing one's financial security or lifestyle. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past Performance is not necessarily indicative of future results. Full Disclaimer Privacy Policy
Interesting Fact: The bright colored coats you would see people wearing on the floor would assist in the identification of specific traders or the exchange members for whom they work. The standard red was given to traders (also called locals) and brokers on the floor, but many opted for their own distinct jacket designs worn by their entire group.
I can still remember when I first stepped foot on the floor of the Chicago Board of Trade in 2002. I was a junior in college and the experience for me was absolutely electrifying. Ultimately it would set me on a path for my entire professional life.
In order to be a successful trader in the pits you had to be an expert at reading the crowd and the moves of the larger players, all while keeping your cool and managing your emotions in a very chaotic environment.
As technology advanced, more and more volume left the floor of the exchanges and went electronic. The advancement of algorithms were pretty much the final nail in the coffin for floor traders as volume dried up.
In 2008 trading algorithms tipped the scales and began accounting for the majority of trading volume. This made it difficult to read a level II as orders were constantly pulled and added to the book. It became very difficult to rely on a level II alone for an edge.
A lesson to to take away is like any competitive industry, advancement is rapid. If you want to make it long term in this business you constantly have to be looking to improve and better define your edges.
Auction Market Theory is a philosophy that financial markets move higher and lower due to imbalances between buyer and seller aggression (caused by market events) until price discovers a level where aggression is balanced and the most trade can be facilitated (Fair Value).
When you begin to incorporate AMT into your core principles and strategies you will begin to feel more empowered as a trader. I believe you become better at reacting to market data and events rather than trying to predict them in the traditional technical sense.
First we have a Level II Or Depth of Market. We use a DOM to analyze areas of high and low liquidity in the book and to help evaluate the aggression of buyers and sellers at different price levels. This is the modern form of reading the tape.
Volume and volume profiles are the backbone areas of focus for all of my strategies. I interpret volume data and profiles to determine if a market is balanced or imbalanced, the strength of trends, determine reversal points, and much more.
The tools and topics covered here will take time. Experience is truly the only way to master any subject and the only way you do that with trading is screen time. You have a lot to learn, so get going!
If you have any questions make sure to leave a comment below!