Wednesday, 21 April 2010

Detecting and Using Order Flow Part 1

We trade order flow as the heading of this blog says and as I was reminded again of this by one of our readers yesterday.

We are getting towards almost 200 posts in this blog and we still have a lot to talk about. We have spoke about order flow in a number of posts and perhaps now we should talk about it in a little more detail. First, we have to define what order flow is and then we need to decide how we can detect it.

For me, order flow is the nett amount of business between the buying and the selling. Orders flow in two directions. In fact, each trade has both a buyer and a seller. On the floor, when a clerk was sent to the pit on behalf of a client to ask why the market went down, we would facetiously answer "more sellers than buyers" as if the person asking was an idiot. But in fact, the answer is not so facetious. Perhaps the answer should more correctly be: "There were more initiating sellers than initiating buyers". Traders like a bargain. They will buy below perceived value and sell above perceived value. On the other hand, other market participants "have" to do business. These netted aggregated large trades in the same direction become the order flow.

Contrary to what many people think, people with a lot of money are not stupid. These large market participants do the best job they can to get the best price they can. Not all large selling orders trade at the bid and not all large buying orders trade at the ask. Clever market participants hide both their size and intentions and often sell at the ask and buy at the bid. This can be done even more easily electronically than it was done in the pit.

For this reason, we need to look at both the volume traded at the bid and at the ask as well as where price is going and how it's going there to get the full picture. I remember seeing a black and white film as a kid about the Invisible Man. When he took off all his bandages, you couldn't see him. So to enable the audience to see what he was doing, the director created his footprints so we could follow his action. This is exactly what we need to do in the markets to monitor order flow. Our tools are Volume Delta (or its proxy of Upticks and Downticks), Market Profile and momentum measurement. Momentum measurement can be done and should be done in various ways including looking at the way that the range bars unfold and the speed with which they are formed.

Putting it all together we have order flow. If we correctly detect order flow then we can make trades with a high win rate.

This is DISCRETIONARY trading. This means that I am trading a picture of what I want to see to put on a trade. That picture is not the same every time. What I want to see in the picture varies depending on context. The arrows and notes on the MarketDelta charts are setups, not trades. As I said before, I can trade either by qualifying a setup's context before I put the trade on or I can just enter every setup by autotrade and then manage it including taking it off if I didn't like the context. At the moment MD is not autotrading. The signals mean that it meets my setup requirements and I then look at the context whether to take the trade or not. The subsequent signals in the same sequence tell me that bar meets my setup requirements, not necessarily the same ones as in the previous signal. It's MultiChart that is doing the FloBot trading but Flo trades in a mechanical fashion and has a different trading plan. It has to take lots of trades with small profits as so far we cannot incorporate all the context into the algorithm.

Part 2 of Detecting and Using Order Flow will examine the thought process I go through in determining the order flow.


  1. Great post EL ! Thanks, looking forward to the next part.

    Thanks for all you do!

  2. Thanks for this post! I very much look forward to part 2.....

  3. Hello Boss,

    Really like the analogy with the invisible man.

    Makes a lot of sense why Flo would have to
    take quick profits in lieu of the difficulty in programming context. Especially momentum, which is key to how far one travels.

    Nothing wrong with a quickie though,
    especially if it happens often...


  4. I feel like you are letting this blog go, all these trades you post, really mean nothing, realistically would you have taken all these trades on this chart? I don't think so, so why bother posting them?

  5. Anon 04:36, a little reading of the blog might be useful for you. Don't you think it's helpful for staying in a trade to see that bars are again or still meeting setup requirements. I know it helps me.

  6. Hi Tom
    What you mean ?? " where price is going and how it's going there".. ?? how fast ??

  7. Wonderful post, please do not become discouraged by the odd detractor that is looking for you to answer all his questions or for you to personally mentor him.
    I've read over 100 books on trading and possibly thousands of articles and know something good when I've found it and your stuff is really good. Just don't stop writing, your articles are a joy to read.
    Regards, Cory

  8. "Don't you think it's helpful for staying in a trade to see that bars are again or still meeting setup requirements. I know it helps me."

    Very good point. That is part of my exit strategy.