There is a great deal of confusion and controversy about what exactly order flow trading is, not to mention how it can be used as a method of profitable trading. We will look at these issues in a series of articles starting today.
What is Order Flow Trading?
Order Flow Trading has a very broad and not necessarily exclusive definition of other trading methods. The key to order flow trading is to anticipate prices where other traders have pending orders in place, particularly major market participants with large orders.
How Is It Done?
Obviously, the flow of orders cannot be traded without “taking levels”. This is one of the reasons why many traders are frightened or intimidated by order flow trading: Traditionally, trading gurus warn their wards by taking levels, telling them to “trade for what they see, not what they think”. This seems like good advice when you look at a chart, mentally take levels and see them all dissipated by the price. However, it doesn’t have to be that way, not if you think a little more about the levels you take and equally important if you use adjusted stop-loss.
Trading Methods with Order Flow
Many gurus teach trading methods based on identifying the likely support and resistance levels, and wait for confirmation of price action when the price reaches these levels. In a sense, this is also trading with order flow, as the method is based on expecting a large number of orders at these levels. However, “real” order flow traders would go a step further and not wait for the confirmation of the price action before entering trading. This seems more dangerous than waiting for confirmation of the price action, but think about it. If you are waiting for the closing of an hourly or four-hour candle before entering, just taking the level would offer you a much better price, putting you in profit already at the moment when the price action traders start to enter. Another advantage of a pure level takeover method is that you can normally use a much tighter stop than you would need after confirmation of the price action. Besides, the stop would be better placed.
To define the order flow, you must first define what type of operation you are trying to do. Most speculators, especially in the forex retail market, are trying to place directional swaps. Directional trading means you go long or short, betting that prices will go up or down. Therefore, if you believe that a currency pair will increase, you will execute a purchase order. If you think a currency pair will fall, you can sell it, also known as “falling short.
This type of trading is called directional trading. It is one of the most common forms of trading, which generally involves many people in the Forex world, the world of hedge funds and retail speculators. Now that you know you want to participate in directional trading, let’s define what order flow it is. The order flow is another term used instead of the transaction flow. The order flow or transaction flow occurs when someone believes that the price of a security will move and then decides to execute an order (transaction) in the market. The individual may want to be aggressive and execute a market order and pay the spread. That’s a potential option. The other option is for that person to enter a limit order or stop order that specifies the flow or transaction of the order to be executed at a given price (limit order) or executed after the market reaches a given price (stop loss order).
Both are various types of order flow. The person executing a market order is executing a more aggressive order because he does not want to sit down and wait for a limit order, which may or may not be filled. The person entering a limit order or stop loss order is generating a more passive form of order flow. These commands may or may not be executed, but they still help a great deal in building the order flow puzzle.
So how do you choose levels? That is the million-dollar question, but in my experience the really fruitful levels are the obvious support or resistance levels formed at previous daily and weekly highs and lows. Order flow traders should learn not to be afraid to trade against the trend. Some of the best order flow trades you will see will be triggered by a very strong and seemingly unstoppable movement in the opposite direction so it is quite frightening to trade against. I will explain why this is so in next week’s article.