Order flow trading involves analyzing the flow of buy and sell orders for a particular stock or other security. The purpose is to identify imbalances and use these imbalances to predict price movements. A higher number of larger buy orders may indicate that the stock price will increase. A higher number of larger sell orders may indicate that it will decrease. Traders who employ order flow strategies often utilize advanced tools to help them. These tools include such things as Level II market access. Level II access displays all active bid and ask orders for a particular security. Knowing who is buying, how much they are buying and at what price can give a trader a competitive advantage over other traders.
Table of Contents
- Introduction
- Auction Market Theory
- What is order flow?
- What is order flow analysis?
- Order flow trading
- Footprint Charts
- Order Flow/Footprint charts trading strategies
- Order Flow Positives
- Order Flow Negatives
- Key Take Aways
- Conclusion
Introduction
For centuries, people have considered being a floor specialist on the New York Stock Exchange a license to print money. The reason for this was that the floor specialist controlled the “book” on the stock. This book contains all the buy and sell orders for that stock. By knowing who was willing to buy, how much they were willing to buy and what price they were willing to pay for it, these floor specialists were not only able to keep an orderly market, but they could easily make money trading for themselves.
Modern traders can now utilize similar tools now available to them through the internet. A wise trader can gain an advantage like the NYSE floor specialists. This article will explore what order flow trading is, what tools and strategies to employ in trading using order flow.
Auction market theory
Order flow trading is based on a concept called Auction Market Theory. AMT is a methodology that proposes that financial markets, particularly stock markets, operate like an auction. This theory states that the supply and demand of buyers and sellers participating in the auction determine prices. The theory states that market prices reflect all available information, including both public and private information and that prices change as new information becomes available. The theory also suggests that market participants, such as traders and investors, act rationally and make decisions based on their self-interest. AMT is based on the idea that markets are always in a state of disequilibrium and that prices will change to reach equilibrium through the continuous interaction of buyers and sellers.
What Is Order Flow
Order flow refers to the buying and selling activity of a particular security, such as a stock. It encompasses all the current orders to buy or sell a stock, as well as data on executed orders and price levels. Information you need for order flow trading can be obtained by use such as tools as Level II access, Time and Sales indicators and footprint charts.
Order Flow Analysis
Order flow analysis is a methodology that traders use to study the current order flow of a stock. This type of analysis looks for imbalances in the orders between the buy side or the sell side. By analyzing the order flow, traders can identify patterns and trends in the buying and selling activity. This can be used to make predictions about future price movements. Order flow analysis is used in conjunction with other more traditional stock analysis techniques. This serves to create a more comprehensive view of the stock. Cash flow traders take advantage of what is happening rather than trying to predict what is going to happen.
Order Flow Trading
Order flow trading involves buying and selling stocks and other equities based on what you discover in your order flow analysis. This involves analyzing the flow of buy and sell orders for a particular security. It also involves identifying the major players and tracking what they are doing. Where are they buying? Where are they selling? Are they hiding the fact that they have a large order? Are they filling in small pieces, so they don’t tip off the market? It also identifies imbalances and predict price movements. For example, a higher number of larger buy orders may indicate that the stock price will increase. A higher number of larger sell orders may indicate that it will decrease.
Footprint Charts
A footprint chart is a type of candle stick chart used to visualize the time and sales data of a security, such as a stock. It is also known as a “volume-at-price” chart. It displays the volume of trades that occurred at each price level, rather than displaying the price and volume data on a separate axis as a traditional candle or bar chart. Each bar on the chart represents the total volume of trades that occurred at a specific price level, and the length of the bar is proportional to the volume of trades. The horizontal axis of the chart represents the price of the security, while the vertical axis represents the volume of trades. The color of the bar indicates the direction of the trades, usually green for buys and red for sells.
Footprint charts are used in order flow analysis, and they can provide traders with a more detailed view of the buying and selling activity of a security, as well as revealing patterns in the trading activity that might not be visible on traditional candle or bar charts. They are particularly useful for identifying patterns of buying and selling activity, such as high-volume price levels, and traders can identify the presence of institutional traders and predict their trading activity.
Order Flow/Footprint Chart trading Strategies
Footprint charts are a type of chart used to analyze the time and sales data of a security, and they are often used in order flow trading. Here are a few examples of trading strategies that can be used with footprint charts:
Volume Profile Volume Profile Analysis: :
Volume Profile Analysis:
Traders can use a footprint chart to analyze the distribution of trading volume across different price levels. Traders can use this information to identify levels of support and resistance and predict price movements.
Institutional Trader Identification:
By utilizing the footprint charts and level II access, traders can identify the presence of institutional traders and track what they are doing in a stock. Are they buying heavily at certain price point? Do they drop out when it hits others? Do they look like they are filling a very large order? In the market you always want to follow the smart money. Tracking and following the actions of the traders from very large trading houses you can start to understand what they are doing and go along for the ride.
Delta Divergence:
Traders can use a footprint chart to analyze the relative difference between the volume of buy and sell orders. This helps us to identify market trends and predict price movements.
Order Imbalance:
Traders can use the footprint chart to identify imbalances between buy and sell orders and predict future price movements based on this information.
Market Internals:
Traders can use the footprint chart to analyze different market internals, such as the advance/decline line, the number of new highs/lows, and the put/call ratio to get a better understanding of the market sentiment.
Note that you should use these strategies alongside other technical indicators like trend lines, moving averages, or volatility indicators to increase the likelihood of a successful trade.
Order Flow Trading Positives
Anyone who has been in the market for any length of time is aware of the concept of order flow. I actually sat on a Nasdaq trading desk as an assistant for a short period of time. This is where I became acutely aware of order flow and how to use it to make money. I don’t personally trade this way, but I am convinced that it is an absolutely solid way to learn how to trade the market. There are many good resources out there if you want to continue your study of this type of trading.
Order Flow Trading Negatives
The only downside we see in order flow trading is that it is a true skill, and it may take you years to get to a level of proficiency. Putting that aside, we believe that this type of trading is a highly effective way to trade in stocks and other types of investments, despite the fact that most people do not want to take on such a commitment.
Key Take Aways
- Order flow trading is a serious and effective way to trade
- Order flow trading will take more learning time than other types of trading
- Footprint charts are the main tool for order flow traders
- There are many ways to use order flow trading. You must find those strategies that best fit with your other beliefs and practices of trading
Conclusion
Order flow trading has been around for a very long time. In this article we have discussed what it is, what tools you must have to do it correctly and some of the strategies that traders use in order flow trading to make money. If you want to learn more, you can find a lot of resources on the internet that delve deeper into this incredibly interesting topic.