Order Flow Analysis | Understand before you regret
What is order flow trading? – Introduction, Strategies & Tools
Introduction & Explanation:
Order Flow Analysis | Understand before you regret Traders try to predict market direction based on exchange-traded volumes. Various tools are used for this, which I would like to explain in this article. It is also possible to read the order flow in a normal chart.
Benefits of order flow trading:
Very well suited for short-term trading (day trading and scalping)
See exactly why the price is moving
Get more information about the market
You have advantages over the normal chart trader?
Insight into the current liquidity in the market
Understand the order flow
Before you start order flow trading, you need to understand order flow. How is the price created on the stock exchange and how do the orders work? – I would like to explain this to you in the following section.
In order flow trading, direct pricing on the stock exchange is observed in most cases. The price can change every millisecond. It is said that the price always changes according to supply and demand. This is correct, but how exactly does it work? In the picture below you can see a screenshot of the order book.
The order book and price determination works through market orders and limit orders. It is important to understand how these two types of orders interact.
Limit orders:
ASK (Sell Limit Orders) and BID (Buy Limit Orders) show the limit orders at different prices. Traders want to buy or sell at a certain price. You are waiting for the order to be executed. Only a market order can trigger a limit order.
With a buy limit order (BID), traders want to buy at a certain price. Limit orders can also be used to close a position. With the sell limit order, traders want to sell at a certain price.
Market orders:
When opening a market order, the order will be filled at the next best price. There is a buy and sell market order. The Buy Market Order triggers the Sell Limit Order (ASK) and the Sell Market Order triggers the Buy Limit Order (BID). Buy Stops or Sell Stops also have the function of a market order and can be used to open or close positions.
The pricing:
In the market, market orders are constantly being networked with limit orders. If there are too few limit orders on the BID or ASK, the price must change. Because the supply or demand is too high.
Tools for order flow trading
The order flow can be displayed with various tools. Exchange information and volume are displayed graphically. There are indicators, order book and many more tools for analysis. In the following section I would like to introduce you to the most well-known tools. The principle is always the same overall, but there are different forms of representation that help to analyze the order flow.
The best-known tools for order flow analysis:
Order book
Volume profiles
Footprint chart
Big Traders/Cluster Search
Volume
This is how you get the data for order flow trading
For order flow trading you need the real exchange data from the respective exchange where you want to trade. There are various data providers that sell the data feed for a small price. Depending on the exchange, the price may vary
You need to connect the trading software to the data feed to see the direct data from the exchange. If you don't include the data feed, the chart won't move…
The data feed is booked via a broker who also links your own trading account at the same time. So you need a broker account with a future broker to book the data. For example, you can open a trading account and deposit a small amount. The data feed for the respective exchange can then be booked in the customer area. The CME data feed costs around $5. European exchanges tend to be more expensive.
Helpful order flow tools
Now I would like to go into various order flow tools and finally a trading strategy. I have already explained the most well-known tool (order book) to you above. The other tools will help you understand the order flow and find perfect trade entries. I personally find it important not to overcomplicate the order flow but to stick to the main information that the market gives you.
Volume profiles
The Volume Profile shows you the volume traded vertically on each price. You can thus see which prices are interesting for traders and which are not. Interpretations can be used to determine whether the price is fair or unfair.
The most traded volume is represented by the VPOC (point of control) (red line). You can also see the "Value Area", which is delimited by the two black lines. The value area is the area with 70% of the total volume traded. According to the volume profile theory, there is a fair price within the value area because a high volume is traded there.
Effective strategies are created with the Volume Profile. For example, you can determine the trend over several days or use important zones as support or resistance. From my experience, the price also likes to react to untouched VPOCs from previous days. This tool should definitely be used by every order flow trader.
Multiple buy and sell imbalances
Stacked imbalances are simply multiple buy or multiple sell imbalances in a narrow price range.
Imbalances are very useful for determining support and resistance levels. If one or more traders aggressively buy or sell in a particular price zone indicated by stacked imbalances, chances are they will defend that level when the price gets back there.
Multiple Selling Imbalances in the Footprint Chart
On the chart above you can see multiple sell imbalances stacked on top of each other in the candle On the following candle, the sellers pushed the price down with stacked sell imbalances, but couldn't go further down as the buyers defended this zone, resulting in a rally.
I find it very beneficial to project these price zones forward on my charts as they occur to mark future support and resistance areas.
Notice I said zones. You may have 4 or 5 imbalances stacked on top of each other with a few price levels in between with no imbalances. These should still be considered valid stacked imbalances.
Imbalances can be used in a number of ways and we will look at some real trading examples later in this post.
Unfinished auctions and finished auctions in the footprint chart
Asset prices move up and down in auctions to find out where buying and selling can take place, creating a market. In a given market, prices move up until they reach a point where no one is interested in buying anymore. Conversely, prices will move down until they reach a point where no one is interested in selling at that level.
Completed auctions in the Footprint Chart
In the chart above you can see the zero bid pressure at the highs of the price bars. A zero bid at the highs of a candle tells you that the market never climbed above that level, there simply weren't enough buyers.
You can also see the same scenario on the sell side where there is zero pressure on supply at the lows.
The zero supply tells us that the price couldn't go a notch higher because there were no passive buyers looking to buy. Likewise, if there is a 0 on the listing, we can see where there were no passive sellers.
Unclosed deals or an unclosed auction occurs when there is no zero at the top of a bar on the bid or at the bottom of a bar on the bid. Unfinished auctions act like magnets, pulling the price towards you. It is likely that the last buyer in the auction was not found in an uptrend or the last seller was found in a downtrend when an unended auction occurs.
See the picture of unfinished auctions:
Uptrends end when the market reaches a price where there are no more passive buyers looking to buy. Bearish trends end when the market reaches a price where no passive sellers want to sell.
A passive buyer or seller is simply a buyer or seller who is more interested in long-term gains, as opposed to a day trader who wants to scalp profit from smaller moves.
Unfinished auctions by themselves are not a trading strategy. As you will see later, I use uncompleted auctions to confirm whether a top or bottom has been set and to spot a possible new trend. They are very useful for validating trades and I will also use them for price targets which I will discuss later.
Benefits of Volume Profile:
Recognize the traded volume by price
Important markers are drawn automatically
determination of the trend
Various volume strategies are possible
Adjustable to any time frame
Order flow strategy with big trades
My order flow trading strategy includes the “Big Trades” or “Cluster Search”. With this indicator you can filter out large positions/trades/volumes in the market and display them graphically. In connection with the technical analysis or the volume profile, this indicator can provide very good entry opportunities.
Perfect order flow trading strategy
In the screenshot above you can see a good way to use the Volume Profile in conjunction with the Big Trades indicator. I have marked the important point in blue for you. The Big Trade indicator automatically shows large traded positions or volumes in the market. Red represents sell positions and green represents buy positions.
What we see here is that the market is showing high volume on yesterday's VPOC. In addition, they are large sell positions (red). This means there has been a lot of selling at this price point, but the market has not fallen further and is going up. You see sell positions being absorbed by strong buyers. After the next candle one finds a perfect entry into this trade.
What to look out for:
High volume can come from opened or closed positions. There are traders who, for various reasons, need to sell large positions quickly. Then the Big Trade indicator can also be triggered. But this is optimal for our strategy. Despite the high sell volume, the market can rise (screenshot above) because buyers hold back.
It is much more important to pay attention to: what does the market do after the high volume and at which specific price is the high volume indicated.
Refine entries with the footprint chart
The footprint chart is another important tool for order flow trading. There you can see the exact number traded or the contracts. I
With the footprint chart you can see how many contracts were traded on the buy (ASK) and sell (BID) side. It is a reflection of the order book. If a limit order is triggered by a market order, the footprint chart will show you this.
Here, too, the most traded volume is displayed This chart representation really shows you what is happening in a candlestick. The trend can also be determined here by a rising or falling VPOC.
You can also see at which prices the market turns or stops because a buyer or seller is countering the market orders. Market pressure can also decrease because no trader wants to buy or sell anymore. The price must then change.
Conclusion: order flow trading brings advantages to your current trading setup
From my experience, order flow trading gives you a huge advantage over normal chart traders. You can analyze exactly why the price changes with the order flow analysis. You get a detailed insight into the mechanism of the stock exchange.
The most important thing is to understand the principle of pricing (Buy Price or sell Price). I explained this at the beginning of this page. This allows trading strategies and successful methods to be derived from order flow trading.
So if you want to learn this method with complete set-up then visit this link.
Good luck with trading!
