Order Flow Trade Strategy

Posted by on Apr 28, 2016 in Blog

Order Flow Trade Strategy – Why it is important to have a good trading strategy.

New traders often overlook the obvious. What is the obvious? That all trades are transparent. What does that mean? It means when a trade occurs in the futures market everyone in the world can see it.

When someone buys a contract at the market or sells a contract at the market they show the entire world their commitment.
When someone buys a contract as the result of working a bid or sells a contract as a result of working an offer, the world can see their intent by looking at the screen and seeing the size on the bid or offer.

Note the two words: commitment and intent. Order flow footprint traders are more concerned with commitment. DOM traders are more concerned with intent.

So what is better? It depends on your style of trading. There are successful DOM traders. There are successful footprint traders. What kind of trader are you?

I am an order flow footprint trader. I am not a DOM trader.

I think that actual trades, where people are committed to a position is much more important that someone working a bid or offer away from the market.

Before people start throwing stones at me, if you are a successful DOM trader, then more power to you. Not everyone can successfully trade a DOM. I think many new traders see videos on trading with a DOM and think it is easy street to happy profits, but the reality is DOM trading takes an understanding of the market most people don’t have and probably never will.

So let me just talk a bit about the difference between a committed trader and the intention of a trader. When a trader enters in to a trade, they are committed to the market, money is on the line. When the market moves it will affect their thought process. When a trader enters an order for big size away from the market there is could be a multitude of reasons why. I will talk about a simple basic interpretation of intent and why I am not a big believer in it for trading purposes.

If the market is trading 1975.00 and someone offers 1000 lots at 1976.00 people will see that and think, WOW, someone has a lot to sell, I better sell some now, in anticipation of the market trading lower. Think about it for a minute, if the market is trading 1975.00 and you could sell it at 1976.00 wouldn’t you want to do that all day long? Of course you would. As the market moves, bids and offers get pulled or added for whatever reasons.

Now if the market jumps up and the 1000 lots on the offer at 1976.00 get lifted in one swoop to me that is much more relevant information to trade off of because it tells me the market was trading 1975.00 yet someone just bought over a 1000 lots at 1976.00. What has changed in the market? You now have a solid reason to take a trade.

Before the trade occurred, what was happening? You had one trader offering 1000 lots at 1976.00 he was showing his intent. If the market moved away or closer to his price he may change his mind and reduce the size of his order or change the price or even cancel the order.
However, when a trader stepped up to the plate and bought 1000 lots at 1976.00 everything changed. The guy offering the 1000 lots is committed to the position as well as the trader who bought 1000 lots at 1976.00. You have 2 traders committed to the market. Is the buyer going to keep buying more? Is the seller going to start covering his shorts if the market starts to move away from his selling price? Depending on how the market starts to move the committed traders will react.

That is why I am an order flow footprint chart trader. Commitment is more important than intent.

Let me put it in simple terms, think of being in a relationship. If you keep thinking of asking out a pretty girl but never do, you are showing intent. What is the point of that? However once you ask the girl out, you are showing commitment, now you have important decisions to make, what to do on your date, where to eat, etc? Maybe that is not the best prime example, but you should get the point.

Do you know what kind of trader you are? You should know before you start trading. A common problem I see with many new traders is they jump from indicator to indicator, from method to method when they can’t make anything work.

Why is that? I think it comes down to one’s own background and introduction to the markets. Over the years one develops their own ideas and concepts of the markets.

I was fortunate to have spent my early trading years on the CME floor where I could see and learn first-hand how the market operates in an auction basis. Later in my career I worked at major trading firms Cargill, JP Morgan, Commerzbank which exposed me to more fundamental supply and demand forces in the market.

I always suggest to new traders to devour all material on Market Profile, especially the writing by Peter Steidlmayer.

The Steidlmayer concept of trading suggests that one should have a strong background on trading so as to ensure overall success. There isn’t really nothing that can assure you that your trading will make you profits, but if you have developed a “sound” background on the business principles behind the market, you’d be able to make smart decisions and avoid irrational losses.

Surprising as it may be, the learning process necessary in trading does not need to be trading specific. In fact, the learning process may start from way back before you thought about starting trading. The thing about trading is that it needs you to be detailed, disciplined, and a smart decision maker. To reach this point, you should have been used to deciding on matters and observing details for a long time and you should have also been trading in a market for some time. In a word, experience and expertise are keys to ensuring ease in trading.

As per the Steidlmayer concept, success in trading could root back to when you were a kid growing up in front of a running family business. Believe it or not, the buy and sell concepts and auctioning all are portals of how things run in the trading market. But perhaps, the best way to be good in trading is being hyper observant while trading. Sure, you want to perfect trading, but before you reach that part you have to gain experience and make room for both error and improvement. In short, learn as you trade.

Learning By Observation

You may find it surprising but it is possible that if you do not know anyone involved in trading, it could help your observational skills, and it’s because you won’t be distracted by any conversations from friends trying to talk up their position or convince you they know everything about trading and if you don’t listen to them you are doomed to fail. It would also help you develop the habit of observing what is happening in the market. Over time you can conclude that when the volume is strong, there are buying imbalances in the market that you could be up for a good trade. This is because when the market is moving on heavy volume, there are aggressive buyers or sellers in the form of market imbalances, that the market tends to move in the same direction. When the volume becomes lighter and there is a period with low activity, the market could change direction or go sideways.

With continued trading you would also notice those one or two days per month when you simply lose money. These are the days when the market moved in one direction with heavy volume. If you have experienced these days you’d realize that these couple of losing days would subtract from your winning days. This is why it is very important to ultimately figure out a way to recognize these trading days so as to be ahead of money instead of being behind your potential.

Trading Day Types And Speed Of Price Change

In recognizing the kind of trading day you are faced with, keep in mind the two basic trading day types – the responsive day and the initiative day. The responsive day can be viewed as a day that is active early but end up running out of gas, while the initiative day can be seen as the kind of trading day that compromises the big days and it develops all day.

Another important element that could help you in reading market behavior has something to do with the speed of price change. The faster the market goes away from a price, the more it indicates that the price is a noncompetitive area of the market, or an excess. The simple principle behind this and its effect on your trading is that this excessive price area – high or low – would be a barrier between the price and its movement towards a direction. This should be one of the most reliable reference points for a trader. However, do keep in mind that these excesses may come in different sample sizes, but they are always there, waiting to occur anytime during a trade. This is why it is very important to recognize them if you want to avoid a no-win trading day.

Market Place Common Laws

It is worth mentioning that all markets are basically the same. The trading market is actually not that far too different from the buy-and-sell market. Look at it this way, the day trader and the investor are both looking at the same price. They are just looking at it from different viewing points.

In the day area, the market’s purpose is to find a fair price so that the trade can start. No one will purposely trade if the price is unfair. In the beyond the day area, price regulates the activity of the buyers and sellers by moving higher or lower. For example, if lots of building activity takes place in a certain real estate market, we can expect that the prices for labor, materials, interest rates, and other related expenses will increase or hold. Professional builders, being experts in market conditions, may as well be willing to pay the high prices knowing that it can go even higher in the near future. The builders’ decision to pay high should be an indication that the prices can go even higher. This value won’t be easily recognizable to the nonprofessionals.

Observations like these give traders a set of circumstances that they can deal with logically. With this, you can conclude that it is possible to read the market using the present tense, without the need to wait after the trade to come up with an assumption. Being able to do this is definitely an advantage to every trader.

Happy Trading.

Mike

    1 Comment

  1. Cheers Mike- Very helpful as always.

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