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I’ve been trying to get my head around order flow for some time now. Watching webinars, youtube videos and reading threads.
My flat brain, it seems, can only comprehend more complex scenarios if it is in picture format. I would therefore like assistance from the smart tape readers/order flow traders out there in correcting or adding to my picture and explanations below to ensure I’m not totally on the wrong path. I won’t take in personal
Also, if there are more flat brains out there, it might also assist them to unravel the (complex) world of order flow.
The first post is slightly long and my apologies for that. I would like to keep all the relevant information on one page and not have to jump around. My goal is to, eventually, have all the most relevant information on easy to understand sheet, print and put it up on the wall next to my computer until such time I have the concepts drilled into my head.
The attached picture shows how I understand order flow and more specifically the DOM.
Group 2 and 4
On the left hand side we have the traders (individuals or institutions) looking to buy. Obviously they would like to buy as low as possible and that is why they are “situated” below the current price. Some of them already have sold contracts previously and would like to buy them back at a lower price. The others in are not in the market yet.
Group 2: They are “showing their hand” by placing orders and they come up on the DOM. Note that although they are visible on the DOM, it doesn’t mean they will want to buy if price ticks to their level. It might mean they have some hidden agenda and try to manipulate the market in a certain direction and then pull their orders.
Group 4: They are watching and may enter the market with a market order if price reach their anticipated target level.
Group 1 and 3
On the right hand side we have the traders (individuals or institutions) looking to sell. They would like to sell as high as possible and that is why they are “situated” above the current price. Some of them already bought contracts previously and would like to sell them back at a higher price. The others are not in the market yet.
Group 1: They are “showing their hand” by placing orders and they come up on the DOM. Note that although they are visible on the DOM, it doesn’t mean they will want to buy.
Group 4: They are watching and may enter the market with a market order if price reach their anticipated target level.
Action 1 and 2
The only way to initiate a transaction is to “cross the road”. This is done by market orders (is this correct?). It means that someone, either a buyer or seller must make an effort to cross over and fill a position on the other side.
Action 1: A trader looking to go short, will decide that the price being offered to sell a contract is fair on the bid side and would therefore actively “engage” with a buyer at that price. This is what is meant by “hitting the bid”.
Action 2: The opposite of action 1. A trader looking to go long, will decide that the price being offered to buy a contract is fair on the ask side and would therefore actively “engage” with a seller at that price.
These actions are displayed on the tape by date, time and size of the order.
Stop 1 and 2
Traders already in the market have a threshold where they would cut their losses if price moves against them. This is indicated by stops on either side depending if the trader is long or short.
Stop 1: Traders (group 1 and 3), who are already in the market by buying contracts previously, want to sell as high as possible. If price however moves against them, they would settle for a lower bid price and rather take a small loss than risk a larger loss. This is indicated by the Stop 1 level. Obviously you won’t know exactly where everybody’s stops are, but knowing that they are there is (it seems) important. I guess if price moves to that levels, you might see it stalled as all those stops are executed and then either continue (if there are enough buyers to further push up the market) or reverse (if all sellers have dried up).
Stop 2: Traders (group 2 and 4), who are already in the market by selling contracts previously, want to buy as low as possible. If price however moves against them, they would settle for a higher ask price and rather take a small loss than risk a larger loss. This is indicated by the Stop 2 level.
What moves the market up
Traders from either group 2 or 4 must actively “cross the road” and absorb orders on the ask side. If all orders at the lowest ask price levels are absorb, price will tick higher and absorb available contracts on the next higher level.
This also goes to show that you don’t necessarily need very high volumes (although it is easier to spot) to change price. If there aren’t that many orders on the ask side, a relatively small amount of traders, looking to buy, can move the market if they manage to absorb all contracts on more than one level.
What moves the market down
The opposite from the above. Traders from either group 1 or 3 must actively “cross the road” and absorb orders on the bid side. If all orders at the highest price levels are absorb, price will tick lower and absorb available contracts on the next lower level.
Ice bergs (please correct me if I’m wrong in my understanding)
Ice bergs happen when a trader from either group 3 or 4 have a large number of contracts to execute, but doesn’t want to make it that obvious. If, for example, a large institution wants to buy 1000 contracts, the trader will be part of group 4, waiting and watching until price move to a level he/she thinks is reasonable. As sellers start hitting the bid at that price, the trader will start buying contracts in smaller bundles. Let’s say 5 batches of 200 contracts each. As soon as the first batch is absorbed, he/she will put in another market order for 200 contracts at that price. This will go on until all 1000 contracts are filled or if other buyers spot this happening and add more market orders until there are no more sellers left at that level and price ticks up.
This is how far I got. Once again, please don't hesitate to correct any misunderstandings I might have about order flow or add any additional comments you might think will help.
Test this - in simulation, place a market buy order, what price do you get filled at, place a market sell order, what price do you get filled at?
Greed and Fear moves the market
If I am in a trade and it goes against me I wisely exit - Why?
Fear of losing more money
If I am in a trade and it goes in my direction and I exit at my PT - Why?
Fear of losing the profit
I am in a trade and it goes in my direction but I do not exit, I hold - Why?
Greed of wanting more profit
The market moves between the balance of buyers and sellers.
When the market total sum of buyers equals the sellers - flat market, sideways, stalls
When the market move up or down, the market is in imbalance
more buyers than sellers - up trend in search of sellers
more sellers than buyers - down trend in search of buyers
When the searching traders find what they are looking for - the market reverts back to a flat market.
It's always in a cycle, repeatedly, at some timeframe.
Reading the market - in hindsight it is easy to identify where the traders come in and where they exit, even if hindsight is measured in seconds - once the trade occurs everyone sees it.
In real time - I "think" where are these locations likely to setup? If traders entered here, where are their obvious stops or profit targets?
And, if the market structure is such that their exits would add validity to my market structure analysis,
I look to enter on their pain, their fear - their exits can fuel the move, sort of a self-fulfilling concept
This is not an exact science - it's based on probabilities and human emotions.
I would like to clarify a few points that I think may help you.
1. I don't think of an iceberg as a person hiding their market orders. I think of an iceberg when someone is hiding their limit orders. For example, the inside bid quantity is 500 but you notice from the volume profile that 5000 traded at that level you know that an iceberg happened. The bidder showed his "intent" of 500 orders but actually bought 5000. I think there also is value in understanding what you previously defined as an iceberg. I often see low bids or offers slowly pump up and then get whacked with a market order once they reach an acceptable size.
2. I think it's important to remember that every executed order can be one of 4 types: Creating a new short position, creating a new long position, exiting a short position, or exiting a long position.
With the addition of the chat box on the blog I have had the pleasure of having some great conversations with my blog readers. I found that many of them are still having some trouble making money, so I wanted to take some time to write this blog post …
I do agree it would be difficult to determine when a limit bid is closing or opening a position but I think it's important for a new orderflow trader to understand that there are bids that simply want to cover their shorts.
When Im looking at my Dom, I will see huge orders in the 5 year treasuries. Im talking about 500-3000 lots. When someone buys a 700 lot why dont they move the market?
It has been some time since that first post of mine and I've been watching webinars and reading quite a lot of stuff on the subject. I'm no expert...yet, but here is my view to explain your question.
By the way, the best explanation I could find explaining order flow was webinars by Pete from Jigsaw Trading. If I remember correctly all the videos are free. You can check out his website.
The market can be moved by as little as 2 contracts. It depends on the how many limit orders the market orders have to "eat" through to break that price level. If for example, you have 1000 buy limit orders at 1.950, it will take 1001 sell market orders hitting that price level to make it tick down to the price below. If there are only 10 buy limit orders at that level it will take only 11 market orders to "eat" through it and tick down. Obviously the reverse is true for sell limit orders. There are therefore two considerations to take into account for a price to tick down/up: 1. The number of limit orders AND the number of market orders hitting that level.
Pete refers to cielings and floors when explaining order flow which is a great analogy.
Just take note of ice berg orders or refreshing orders. That subject is also explained in his webinars.
