Order Flow Trading
What is order flow trading? In order to define order flow trading one would first need to delineate exactly the type of trading one is discussing. There is quite a bit of dialogue about order flow trading and misperceptions abound as to the most efficacious manner in which to use this trading method.
Some describe order flow trading as directional trading, i.e., you are betting that prices will either move up or down. If you believe a currency pair will go up, you will execute a buy order, going long. If you believe a currency pair will fall, you can sell it, shorting the trade.
Order Flow-Transaction Flow
Order flow can also be referred to as transaction flow. Transaction flow takes place when someone believes the price of a security will move and then executes an order in the market. The individual can do this in two ways. He can take an aggressive approach by executing a market order and paying the spread. Or he can enter a limit order or stop order specifying that the execution of the transaction should take place at a certain price (limit order) or executed after the market hits a certain price (stop loss order). These are both considered order flow trading methods.
In fact, the basic tenet of order flow trading is being able to forecast the prices prominent traders will elect and setting up a position where you can take advantage of that order flow. As can be expected, the market will only move significantly when there is sufficient market orders in place and large buy and sell orders await execution. This requisite to uncover specific patterns or trends and to constantly anticipate what other market participants are doing can often lead to greed in the market. It may also create an anxious environment for beginner traders who are intimidated by the need to watch for these levels.
There are many who feel that Forex markets are controlled by big banks and financial institutions and that it is up to the new as well as the experienced individual Forex investor to determine accurately the order flow in the markets in order to ensure that their trades are in synchronization with that of the big banks and institutions. Since these big institutions are at the receiving end of giant players such as Bank of America and Merrill Lynch, they will always control the direction of the markets and it would be prudent for novice and small traders not to trade against them.
Under these circumstances, the question remains: How do we determine Order Flow? The long and the short of it is this: It all depends who is making the determination. A technical chartist, for example, has the ability to look at a Forex pair chart and immediately spot the likelihood of a pair moving up or down. How does he spot these moves?
He uses a MACD indicator. Moving Average Convergence Divergence is a technical analysis momentum indicator used to analyze financial markets. The indicator, like the name suggests, measures the convergence and divergence of moving averages. A MACD is most often used as a lagging indicator that mimics the behavior of any traded instrument. However, it can also be used as a leading indicator, predicting the direction of the instrument in advance of any profitable move.