Order Flow Trading

[Metagamer]

Hi,

I've found a few months ago some interesting discussions about a trading method called Order Flow trading and I'm wondering if anyone else on the forum here is applying something similar? I've learnt most about it from Daemon Goldsmith's book "Order Flow Trading", research papers about market microstructure and trading forums.

I'm relatively new to this, but from what I've understood, the primary goal is predicting future order flow in the markets by "reading sentiment" and understanding what other market participants do. I'm now applying the basic concepts I've got from the book, it is about hunting stops of the traders that are on the wrong side of the markets - trading against sentiment. An example would be hunting the sell stops of traders that are long AUD/USD despite negative fundamentals/sentiment.

I've had great results so far, but I haven't spent enough time yet applying the method and I will probably need to test out other strategies too. But it seems much better than technical analysis because we can understand much clearer why certain things occur in the markets. It seems price moves are not that random as I've thought previously.

So if there is anyone a bit more experienced in applying the method - please share your insights! I think we can build a great thread with an interesting discussion.

Cheers

 

[goldmember1]

In my opinion (and others might differ) there is no way that you can trade order flow in forex because you do not have access to the order book. The level 2 that you might have for your broker is broker specific and only covers <0.01% of the market - there is no way you can work out flow from it. Some people don't even bother with the book and use the 'tick chart' or 'volume' to work it out - again one broker varies from the next (and they make up a minority of the orders in the market) so its actually not a valid system to use at all.

 

[Metagamer]

In my opinion (and others might differ) there is no way that you can trade order flow in forex because you do not have access to the order book. The level 2 that you might have for your broker is broker specific and only covers <0.01% of the market - there is no way you can work out flow from it. Some people don't even bother with the book and use the 'tick chart' or 'volume' to work it out - again one broker varies from the next (and they make up a minority of the orders in the market) so its actually not a valid system to use at all.

Hi,

I agree, Level 2 is useless in FX because it is a decentralized (OTC) market and I doubt the data from any retail broker matters in such a large market. But trading order flow has a wider meaning than trading off the books (Level 2 / Depth of Market etc), it is more about taking advantage of the predictable behavior of other traders.

There were several research papers about the FX market that indicated that even large traders (institutional) placed their orders around big figures (i.e. 1.30, 1.31, 1.32 and so on...) and mid figures (i.e. 1.3050, 1.3150, 1.3250 etc), as well as their stop orders above/below. What gives them an advantage is that they consider fundamentals and market sentiment.

If you think about it, this is also what we have been taught the whole time by all those mentors and their trading courses. Place your stop below the support level/above the resistance level, Fibonacci level, Moving average or any other technical analyis tool. This leaves us vulnerable to the participants which are more knowledgable and know where the stops reside.

I think it would be interesting if we just think a bit more deeply about where EXACTLY we place our stop.

Order Flow Trading isn't just about stops - its much more than that. It's just the topic I'm currently doing most of my research.

 

[Metagamer]

I have found that stop hunting tends to be even more profitable when a certain side of the market gets squeezed. This is often connected to the market being clearly positioned on one side (i.e. a lot of traders are long USD/JPY), but unable to push through a key support or resistance level.

For example, yesterday, we were unable to break below 1.2940 in EUR/USD and this led to a squeeze of short positions and a stop hunt above 1.30 during the Asian trading session. My point is that as positioning is extreme to one side, those traders are more vulnerable to a squeeze. Markets are driven by fear and greed and most traders just feel uncomfortable seeing a trade going against them, especially if is already in a profit.

The reason why this happens is mostly the process of distribution by larger players, which is followed by the order flow of contrarian traders and position covering by weak traders.

Let me know if you have any questions, I'll try my best to explain.

 

[Metagamer]

Here is an example of an Order Flow analysis on GBP/USD.

Sentiment is currently negative with weak UK fundamentals and improving US fundamentals, which leads to a positive bias for the US Dollar and a negative bias for the Pound. It does not take much fundamental analysis to come to this conclusion, simply read the key headlines on sites like Bloomberg or Reuters. Make note of the main topics traders are talking about (like currently -> the possibility of the FED decreasing its QE operations).

So a lot of traders are short GBP/USD and the prevailing market bias is down based on fundamentals. But we can also analyze market bias from a more technical perspective. Key support/resistance levels are also psychological levels, even when their not at a round figure. The area where the most volume traded (seen on the chart as an area of consodlidation followed by a clear move either up or down) will have an psychological impact on other traders.

For GBP/USD these are currently 1.5220 and 1.5260. Not only will a lot of stop loss orders build above those levels, but once we get a clear break above, traders that are short will consider taking profits or closing their position because the whole process could lead to acceleration in upside momentum and ultimately, a short squeeze.

As Order flow traders we must carefully watch this levels and perceive price from a different perspective. Think about the psychology attached to this. Think what other traders could do/will likely do. Professionals may have better insights than we have as retail traders, but they use stops too, if not technical then mental. There is a point where he/she has been proven wrong.

 

[Giovan]

Hello there, this is the close to my system although I have taken lots of time to learn how to read order flow and have integrated tick volumes into the bare charts. Keep going you are on the right track.