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Order Flow Trading Software

by | Sep 11, 2020 | Forex Trading |

Order Flow Trading Software

What Is Order Flow Trading?

Order Flow Trading is a type of trading where the trader predicts the price movement based on the current orders that enter the market. The term order flow refers to the buy and sell orders that flow into the market from different traders making decisions such as closing trades and making profit. It also refers to the contracts that are bought and sold at a certain price. Short-term traders would benefit more in using order flow as this method allows them to see why the market is moving and where is the best time to enter and exit trades. It also allows traders to analyze the market faster to identify important support and resistance areas. Long-term traders may not benefit from order flow trading as they use fundamental analysis to scrutinize the market conditions. 

In order flow trading, the trading decisions of buyers and sellers are the vital factors. Their decisions translate into different types of orders that show how the market is moving. These order types are:

  • Market orders. This order type refers to the buy or sell order which a trader places when he spots an opportunity to make a profit. A market order is executed immediately at the current market price without any price limit.
  • Limit orders. This type of order is also known as a pending order which is used when a trader wants to buy or sell at a certain price. Unlike a market order, a limit order is not executed immediately. A buy limit order will only be executed when it hits the limit price or lower while a sell limit order will only be executed when it hits the limit price or higher. This gives the trader more control over the buying and selling prices of their trades.
  • Stop orders. A stop order is used as a risk management tool and also as a way to enter the market. It turns into a market order once the price of a financial instrument reaches a specified price or stop price.

Another trading concept that a trader should know when it comes to order flow trading is liquidity. Liquidity refers to the ease of buying or selling a financial instrument in the market. If the market is liquid, it means it is easier to buy and sell. The market is considered illiquid if there is difficulty in buying and selling of financial instruments. In this trading method, traders need to check for buying limits or selling limits that are available for trading.  

Most traders use order flow trading in the stocks and futures markets as they have high liquidity. Markets with low liquidity can be difficult to predict the price movements, therefore, order flow trading is not recommended.

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What Does A Flow Trader Do?

A flow trader makes trades based not on certain rules but on how other traders make decisions. These decisions affect the movement of prices in the market and traders keep track of the order flow in order to find the most profitable trades. Having at least some knowledge of how traders work in the market is beneficial for a flow trader. 

When it comes to order flow trading, the trader should also know the traders that are essentially the reason for price movements in the market. Usually, these traders are large groups or financial institutions who make huge amounts of trades. If the perspective is narrowed down to how these groups trade, it will be relatively easier to determine the best time to place a trade. 

Traders use order flow trading for the following reasons:

  • Identify trends to predict the direction of the market
  • Identify possible reversals
  • Confirm support and resistance levels
  • Defining exact entry and exit points

What is Order Flow Analysis?

Order flow analysis is also called reading the tape and provides a better understanding of the market. It can be used to predict the direction the market will move depending on the buying and selling demand and supply. This is why it is important that a trader has grasped the concept of the different order types and what they do to the market. 

Basically, market orders consume liquidity while limit orders add liquidity. Stop orders can either provide liquidity as they are a type of limit order or consume liquidity once the stop price is reached. A limit order is filled once a market order is triggered. When the number of buy market orders match the number of sell limit orders, it signals an uptrend and liquidity is taken off. However, in a downtrend market, sell market orders consume liquidity provided by buy limit orders. 

Order flow is established if there is a balance or an imbalance in terms of buyers and sellers. There are instances where the market sell orders overpower buy limit orders and sometimes, the market buy orders overpower limit sell orders. These causes the prices move because, in order to trade the market, liquidity should be provided (represented by limit orders) or liquidity should be consumed through the use of market orders.

Order Flow Trading Indicators

When it comes to order flow trading, one of the most important things one has to understand is the depth of market (DOM). The DOM is a list that displays real-time bids and asks at the current best prices. It is also sometimes called the “order book” which is used as an indicator to understand order flow. 

In the order book, there are three parts: Bid (buy), Ask (sell), and the current price of the security or financial instrument. The bids represent the amount a buyer wants to purchase at a certain price point or lower. The asks represent the amount a seller wants to sell at a certain price point or higher. The current price refers to the price at which the last trade occurred. Keep in mind that the bids and asks are all limit orders, meaning they would not be filled unless a buyer with a market order enters. 

The order book is a useful tool in determining imbalances of buy orders and sell orders which create price movements. If a trader identifies any imbalances, the short-term direction of a financial instrument can be predicted. However, it is difficult to create a trading strategy just from looking at the order book so it is highly recommended to use other tools such as:

  • Volume profiling which shows the volume traded at a certain price and shows where price is most likely to consolidate
  • Volume Weighted Average Price which shows the average price of a security or financial instrument based on volume and price
  • Cluster or footprints chart which shows the exact traded volume at a certain price
  • Volume histogram which displays volume trends and buying or selling pressure

Using a standard chat in order flow trading is not enough since the trader would not be able to have an in-depth understanding of the movement of prices. For order flow trading, all important information about the price movement lie in the buying or selling pressure. Using the order book plus the combination of the indicators above would give more details about price action which other traders may not even know about. Since order flow can be dynamic, the usual technical indicators may not be appropriate.

What Is Order Flow Chart?

The order flow chart is a visualization of the data gathered in making trades, particularly the volume traded at a certain price and at a bid and ask. This chart allows the trader to get more insights and additional market information which can be analyzed in real-time. As mentioned before, one of the aspects of order flow trading is determining how traders make decisions that affect the price movement. With the order flow chart, a trader can see whether buyers or sellers are controlling the market and how their buy or sell orders affect price action. This will lead to a better calculation of what direction will the market move to.

When used correctly, the order flow chart can help identify the support and resistance levels and the best time to enter and exit a trade. However, using the chart alone can be limiting especially if the trader does not have enough skill and experience. Just like in other trading methods, a trader should use the order flow chart and additional tools to have a successful trading.

Order Flow Trading Strategy

In order flow trading, one should know how other traders make decisions. Although it is hard to find out exactly how much they are going to trade, knowing the distinct traits of technical traders can actually help in determining the areas where they will most likely hold positions. These areas also probably have more technical indicators or tools such as trendlines and support and resistance levels that will signify more trade volume, therefore, more order flow. 

Technical traders will likely buy when the price reaches support level and sell when it reaches resistance level. They will also put a stop order beyond the extremes as preparation in case a breakout happens in the next support and resistance levels. With this knowledge, it is easier to identify the areas with the most profitable trades.

As always, best of luck!

 

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