TOP-5 advice for beginner traders: how to read the order flow.

TOP-5 advice for beginner traders: how to read the order flow.

The name of our website (orderflowtrading.net) speaks for itself – ‘order flow trading’. There is a good reason behind this name. We are sure that an ability to work with an order flow is very important. We will discuss the basics of the topic in this article.

Perhaps, this information is well-known for some readers. But if you’ve got acquainted with ATAS recently only, this article will help you to figure out what to start from.

Are you able to forecast weather for a week by clouds, pressure and air humidity? Or are you just able to say with confidence that there would be no rain in the nearest 5 minutes, since the sky is blue? The same is true for the exchange price movement – it is much simpler to see what happens right now than to try to forecast where the market would be in a week.

In this article – in simple words:

  • What the order flow is?
  • What traders use the order flow for?
  • Why prices move and stop?
  • Components of the order flow.
  • What price movements are seen better on the order flow than on the candle chart?
  • Footprint examples.
  • Examples with the delta and cumulative delta.
  • Examples in Smart DOM, Smart Tape, Spread Tape.
  • Examples with the Market Profile.

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What the order flow is?

The order flow term in this article stands for a conditional ‘complex’, which includes 2 components:

  • intentions limit orders, same as Smart DOM, market depth and order book;
  • executed trades or behaviour – the trades that are registered in Smart Tape, same as Order Flow indicator, Time-and-Sales Tape and trading history.

The exchange trading takes place at the junction of these components when a market order meets a limit order.

Working with this complex order flow is not a mechanical approach to opening trades on the basis of some specific signal like MA (Moving Average) and price crossing. Understanding the order flow allows a trader to decide whether it makes sense to enter a trade namely at this level and whether it makes sense to hold the trade if the trader is already in it.

We can compare the order flow with a book. All books are different, but the letters of one alphabet are the same. We learn letters, then we learn to read and only after that we read fluently and enjoy it. The same is true for the order flow – you start enjoying it only after some time, having passed the period of receiving painful bruises and scratches.

What traders use the order flow for?

  • Identification of a local trend for selecting a trading direction.
  • Identification of an impulse. You can also come across another term – momentum.
  • Identification of reversals by specific signs (absorption and entry into a trade of an opposite aggressive side).
  • Confirmation of the point of entry into a trade. Selection of such an entry point, in which the price would immediately move in our favour.
  • Search for the second chance for entering a trade, if we missed the initial impulse. The market moves in steps, rolls back, tests the broken levels and, as a rule, gives the second chance to enter the trade. Such ‘second chances’ are not evident in candle charts.
  • Pure scalping or immediate profit in 1-2 ticks.
  • Refusal from unconfirmed setups and trades with a high risk. The order flow allows moving together with the market rather than ‘catching falling knives’.

Why prices move and stop?

All traders (and not only traders) wonder why actually the prices move.

What is the difference between the forward market and stock or currency market? The forward market is a game with a zero sum, which means that there is a buyer and seller for each executed contract. The number of executed (opened) contracts is not limited and it does not depend on the volume, since the majority of futures contracts do not envisage physical delivery of the underlying asset (what futures are ).

A frequent mistake of traders is that they believe that there are more sellers or buyers in the market. As we already explained, it makes no sense for the futures markets.

In fact, one of the sides is more aggressive and impatient than the other one.

A more proper question, from the point of view of the order flow, would be not why prices move but what stops the prices. If you are a buyer, then the liquidity is the ability of traders to trade with you. Market orders are liquidity consumers. Limit orders (bids and asks) are liquidity suppliers. Limit orders create obstacles on the way of market orders.

In a household environment, you can compare limit orders with the floor and the ceiling in a flat. In order to break the floor or ceiling in your flat, you need to undertake some efforts, and, sometimes, even very strong efforts cannot break your floor or ceiling.

The same happens in the market. In order to pass through the limit orders, the market orders should ‘eat’ them, in other words, there should be more market than limit orders at the current level of demand or supply. And the price moves further up or down only after that.

Do you find it too difficult? Let’s check an example.

We will show Smart DOM on an EUR/USD exchange rate futures (EDU9).

Order book and order flow
  • Black rectangle to the left marks limit buy orders. There are no limit buy orders or buyers’ liquidity above 1.1281. We marked the movement of the market sell orders with a red arrow.
  • We marked the level, at which 2,286 limit buy orders accumulated, with number 3. If the price reaches them and the orders do not disappear, it would be the ‘floor’, which would stop the market sell orders for some time.
  • Black rectangle to the right marks limit sell orders. There are no limit sell orders or sellers’ liquidity below 1.1282. We marked the movement of the market buy orders with a green arrow.
  • We marked the level, at which many limit sell orders accumulated, with number 4. If the price reaches them and the orders do not disappear, it would be the ‘ceiling’, which would stop the market buy orders for some time.

Now, let’s come back to your flat and imagine that you made a hole in the floor and fell through it. Would you be able to come back to your flat? Of course, you would but only until someone repairs your floor. If someone repairs your floor, you will not be able to come back through that place where the hole was.

The same happens with prices. When prices sharply go up and ‘eat’ limit sell orders, there would not be limit orders behind them for some time. It is a vacuum, through which it is easy to come back. Some time is required to fill this vacuum, fortunately, much less time than to repair the floor in your flat. That is why, bounces, which take place immediately after sharp price movements, are not counter-trends but absence of liquidity or vacuum, which is not yet filled.

Order flow derivatives.

All order flow derivatives are a reflection of the similarly important exchange information but in different variants and at different view angles.

What price movements are seen better on the order flow than on the candle chart?

  • Absorption. New market orders appear all the time but the price doesn’t move. It means that limit orders absorb the market orders. Do you remember what we discussed above? The market orders should ‘eat’ the limit orders in order to break a level. But the market orders ‘splutter’ when there are too many limit orders.
  • Disappearance of buyers/sellers. A significant reduction of a number of limit orders at a certain price level.
  • Aggressive entry of the opposite side. A significant increase of the market orders, which are opposite to the local movement, at a certain price level.
  • Ranges. Price levels, which attracted a bigger number of traders. Or the opposite – price levels, at which no one wanted to trade.
  • Rollbacks. Correction movements against the current trend.

On examples below, we will show you how these movements look like for different instruments of the volume analysis.

Footprint examples.

Footprint is a unique instrument, which is easily read in the real-time mode. It shows the order flow not only with numbers but also with colors. There are more than 25 footprint types in ATAS and any trader can find exactly what he needs.

Here’s an example in the E-mini S&P 500 futures (ESU9) range chart (4). Such charts are not connected with time, and they are good at filtering out the market noise. See Picture 2.

Order flow in the footprint
  • We marked absorption with point 1. The volume by bids and asks in the marked cells is much higher than in all previous bars, but the price, practically, does not move.
  • Note the delta, which we marked with number 2. The delta with a tail tells us a story of how the buyers were very keen to move the price further, but the sellers opposed them. First, limit sell orders didn’t allow the price to grow, then aggressive market sell orders emerged and pressed the price down. The sellers were aggressive for a short time. Most probably, serious players wanted to get confirmation that the price growth stopped and there are no traders who wish to buy.
  • We marked the bar, where there are only 22 market buy orders on the very top – compare it with the quantity at the moment of the price growth – 614,932,786, with number 3. Such an insignificant number confirms that the buyers were ‘exhausted’. At the same time we see the delta divergence – we marked it with a red arrow in the chart. The price reaches a new peak, while the delta doesn’t because no one wants to buy.

Examples with the delta and cumulative delta.

Let’s look at the delta attentively and consider one more example in the same E-mini S&P 500 futures (ESU9) range chart (4).

Order flow in the footprint with the delta

There is no evident absorption here, but the delta divergence works very well – we marked it with a red arrow again.

  • We marked the first local price high with point 1. Some sellers emerged there but not many, while the buyers didn’t disappear.
  • And no one wanted to buy at the very high in point 2 – just 48 market buy orders.

The cumulative delta works better in less volatile markets and it shows the current trend and reversals very clearly. The cumulative delta is not read so good in very volatile (oil, for example) markets.

Let’s consider an example in the E-mini S&P 500 futures (ESU9) tick chart (2000). These charts are also not connected with time – a new bar is built as soon as 2,000 trades are registered.

Flow of trades on the exchange

Apart from the cumulative delta we added the ZigZag pro indicator, which changes direction every 15 ticks, to the chart. ZigZag pro is required for additional confirmation of a reversal, which the cumulative delta shows.

In this case, we consider the global picture of the day. The price gradually moved down and the cumulative delta shows a reversal in point 3. Enter a long by this signal if you are an aggressive trader. Cautious traders want to see additional confirmation signals:

  • Entry of buyers – we marked the real emergence of buyers with point 1. The maximum volume is on the upward wave from the beginning of the trading session.
  • Disappearance of sellers – we can see a rollback with the minimum volume on the downward wave from the beginning of the trading session in point 2.
  • Delta growth. 6 thousand contracts emerged from point 3 to point 4. If you are a cautious trader, enter after this rollback.

Examples in Smart DOM, Smart Tape and Spread Tape.

The main difference between the DOM and footprint is that DOM shows intentions (limit orders). Intentions are often deceitful and confuse beginners. We wrote a separate article about spoofing with the help of limit orders.

The Smart Tape shows market orders and ease of movement. The Spread Tape shows volumes and delta at a spread change. If we combine these three instruments, we will not get an explosive mixture but an excellent variant of analysis of the price movement in the real-time mode.

Let’s consider an example of the Moscow Exchange index futures (MXU9).

Order flow in the futures market

First, a couple of words about the chart legend.

  • Red rectangles are round levels. They have the informative load only.
  • L1, L2 and L3 are the levels of gradual expansion of the day’s Low during a trading session. In other words, the price broke the Low (L) first and reached the Low1 (L1) level and then rolled back. Then it broke Low1 (L1) and so on. Any trader puts these and other marks for himself.
  • We marked the Smart DOM level, at which especially many trades were done, with number 1. We got interested in this level after we saw big new buys on the tape. The Open Interest grows, which means that these are new contracts rather than the closure of old positions.
  • Number 3 marks the price levels at which traders bought.
  • We marked the delta, which grew approximately by 100 contracts, with number 2. We calculate from top to bottom – from the earlier to the later time. At first sight, the new buys should move the price up. But not in this case.

We marked a very useful column in the tape – Up Tick & Down Tick – with number 4. Ideally, if traders buy, we see + or several +++ in this column. If traders sell, we see – or several — in this column. But if we see – at buys, it works as a divergence. That is, traders buy, but the price doesn’t move higher, instead it moves lower. If we observe many consequent minus signs during buys in the green area, it is bad. It is a red light for buyers. It is a primitive explanation and you shouldn’t apply it mechanically.

In this example we consider a combination of factors:

  • appearance of new buy orders – we see it from the OI growth;
  • accumulation of new buy orders approximately at the same price level – we see it from the delta increase;
  • absence of the price growth during buys and even some reduction – we see it from Up Tick & Down Tick.

We make a conclusion that we want to sell at this level. The ground for this is that new buy orders ‘bump into the ceiling’ and cannot break it. Sooner or later the traders would realize that and start to exit from long positions. As soon as it happens, we would see a sharp downward movement.

The result is in the following chart.

Order flow on the exchange

The price fell from 280,925 down to 280,450. The delta was 263 at 18:02 and it became 148 at 18:43. Most probably, these are those unlucky buyers.

This beautiful story with absorption and delta works even better at day’s highs and lows. A bit of rain on your parade – not a single beautiful story works in 100% of cases, that is why use protective strategies.

Examples with the Market Profile.

An intraday Market Profile shows where trades took place and what price levels are of interest for traders. We see a profile in Smart DOM or directly in the chart. Traders are interested not in the absolute volume in a profile, but a profile increment. The profile increment is a sharp change of a number of traded contracts at the neighbouring price levels.

In order to understand faster what we speak about, let’s consider a 5-minute Five Year Treasury Note futures (ZFU9) chart and Smart DOM.

Order flow and analysis

We marked three balanced profile areas with numbers 1, 2 and 3. Formation of such areas takes time – the price moves up and down in a rather narrow range. Sooner or later the price breaks the balanced areas.

We see a sharp acceleration and a change of the profile increment at the moments of breakout – red arrows 4 and 5. The narrower a balanced area is, the faster a breakout would happen. It is very profitable to trade these breakouts, because a risk is lower than a potential profit. The range breakout trades are called initiative trades. We discussed them in the earlier articles about the Market Profile.

The price movement was obviously downward in our chart. The maximum volumes of each of the balanced areas increased during the downward movement. We marked these volumes with red arrows in the book – 11,624, 16,394 and 16,505. The price slows down in the high volume areas and quickly passes the low volume areas. This is exactly what the profile shows and what you can use in trading.

Conclusions.

In order to trade profitably, you need:

  • to know and understand why prices stop;
  • to see (and not just to look at) what actually happens in the market in the real-time mode.

Components of the ATAS order flow will simplify the market analysis and help you to get down to bedrock. You do not have to forecast what happens in the market in a week, month or year for intraday trading and/or scalping. Make money here and now – just join the dominating side. ATAS will also help you to jump out of the train, heading for the abyss, in due time.

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