Order flow trading has become a popular style particularly among futures traders in recent years yet many techniques which are called order flow are really nothing more than a different form of technical analysis. So let’s have a look at the myths and realities of order flow trading.
Order flow trading has become increasingly popular in particular with more experienced traders. Those who try it typically have come from the large percentage of traders who tried technical analysis and suffered losses. These are traders who came to understand that the assumptions and reliability of chart patterns and indicators were poor and did not reflect how markets really operated. So they wanted to learn something more professional and order flow trading appeared to be the answer.
So too does the noise
While order flow trading is indeed a more professional approach, as its popularity increased among retail traders so too did the noise surrounding it. ‘Educators’ with no experience or understanding of real order flow trading saw an opportunity and jumped on the bandwagon. The result is that today, there is so much noise and misinformation about order flow trading that traders will struggle to see what is right and what is bull.
What order flow trading should be
In its purest form, order flow trading is literally trading in and out of the flow of orders as they enter the market, typically using market making style skills. Pure order flow traders should not really be seen (although we know they are there); they are not trying to move the market.
Ideally order flow traders try to pick off the weakest orders in the market or those with some flaws. Obviously do do this requires an understanding of what weak or flawed orders look like.
Pure order flow traders do not use ‘levels’ or ‘key prices’. They can trade on any price at any time. As much as anything it is a style where liquidity and type of market action are more important than the price. If you think about it, the term ‘order flow’ implies liquidity so any technique that claims to be an order flow style must involve some judgment of liquidity and the order book at the time a trade is entered.
Pure order flow traders should be in and out of trades very quickly and it is therefore a higher frequency form of trading. Trades are measured in seconds rather than minutes which makes sense if you consider that the order book is constantly changing. If you hold a trade for even a few minutes you are no longer trading the order flow of when you entered the trade.
When you hear or read about firms such as Citadel buying retail order flow they are not trying to trade at certain levels, they are willing and happy to trade at any price in and out of the flow of weak orders.
As the popularity of order flow trading increased so too of course did the rise of noise and misinformation. Some saw an opportunity to exploit and today the whole concept of order flow trading has become a muddled mess with some complete nonsense now becoming accepted wisdom in the retail trading world. Much of what is called order flow trading is just a different form of technical analysis.
So let’s look at some simple ways to spot methods which are NOT order flow trading:
- If the style solely uses charts
- If a previous volume area is the sole/main indicator
- If there is no consideration for liquidity and order flow at the time of the trade i.e. just based on past information
- If the trade is held for several minutes or even longer
- If any technical analysis indicators are being used
- If to enter the trade you are told to buy on the offer (to go long) or sell to the bid (to short)
These six points probably knock out over 90% of order flow strategies being sold to retail traders
In the now
Perhaps the key distinction as to whether a style really is order flow trading is whether current, realtime information is being used for a trade that will be exited in a few seconds or less.
There are styles of trading where some order flow analysis is being used but the timeframe is much longer. This is not order flow trading. Rather order flow analysis is being used as part of the process. This is still a direction/predictive style trade because the trader will have no idea what the order flow will be around the exit or indeed when the exit will be.
The Norden Method for example, incorporates order flow information to analyse the exit trade before the trade is even entered. So order flow is part of the entry and exit at the time of the trade.
Like every aspect of the trading industry, order flow trading has been overrun with bullsh*t. Forms of trading which are essentially versions of technical analysis have been repackaged and rebadged as order flow trading. So much so that on retail internet forms and discussion boards, the term order flow trading could be almost anything.
If the technique does not involve an analysis of the order book and liquidity at the moment the trade is entered then it is really just another form of position trade and not a form of order flow trading.
Similarly if you do not know the order flow and market conditions of the exit before you enter the trade, then again it is not an order flow style. It is at best part order flow.
As a strong supporter of using real order flow techniques I am pleased that an increasing number of retail traders are seeking to use them. But many of the so-called order flow styles being sold will just lead you to the same type of losing performance as the technical analysis traders.
If you use the checklist above you will be able to quickly sort through the noise and find the real order flow techniques.