[B][U]Order Flow Trading[/U][/B]
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[B][U]What Is Order Flow Trading and What It Is Not[/U][/B]
Order Flow Trading is a term that can create a lot of confusion. Some people think it is trading directly from flow information from banks (info that only a small circle of people have access to and they surely won’t share it on the internet), some think it is tape reading and some that it is simply another form of price action.
There is no clear definition and in the end, all above mentioned methods are based on anticipation of future order flow in the markets. The way I view it is that OFT is a mindset. Instead of just looking for technical patterns, we go one step ahead and think about what other market participants might do. It’s all fear and greed in the markets and we can see this every day in the market.
It’s a big change for newbies, especially those that previously used only technical analysis. But like any other activity, it becomes easier with time and you start to view the market with completely different eyes. You are aware how price is moving, in which manner it moves (not as good as bank flow info, but PA gives some good insights), your knowledge about other participants helps you avoid common mistakes and finally, your knowledge about market inefficiencies will help you combine all this and exploit those opportunities in live trading.
One could argue a lot about the term of OFT, but for me, it is a way of thinking – a different approach to the markets than the common ones, not something limited to a particular method. I don’t have any private bank flow information, but still, my knowledge about market microstructure and other market participants are giving me an edge in the markets.
How did I got into it? I found a thread on another forex forum from the user „Darkstar“ that mentioned OFT. It looked all quite complicated and even after reading the whole thread, it didn’t make too much sense for me. I then found his website later and bought his book (I don’t want to be accused of promoting here anything, so NO link, but a quick Google search for „order flow trading darkstar“ or the title of the book - “Order Flow Trading for Fun and Profit” should do it). It has a very high price for a book, but it changed a lot for me and it was a turning point for my trading career. The chat room is a bit unorganized sometimes, but there are some great traders there willing to help. The forum unfortunately is almost dead, another reason why I picked BabyPips as platform for my thread. Again, I don’t want to promote here anything, I just think it is fair I share how I discovered OFT and give other the opportunities to check out the source where I learned it. After all, there is also some free material availaible about it.
[B][U]What are the steps to learn OFT?[/U][/B]
[ul]
[li]Learn about market microstructure (how price change, type of orders, liquidity etc.)
[/li][li]Learn about the other market participants (commercials, banks/dealers, real money, sovereigns, large speculators)
[/li][li]Exploit market inefficiencies
[/li][/ul]
I will cover various topics in the upcoming articles and go gradually from Step 1 to Step 3.
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Blue font looks mighty familiar. All the best mate. Knowledge sharing is very much welcome here. Will keep an eye on your progress
All the best. Hope this thread won’t get closed like the previous one’s.
Interesting thread. Subscribing 
Type of Orders and How Price Changes
In this article, I will cover the three main type of orders used in trading and how price changes. We will take a look what really happens and what is moving price.
First of all, there is the term liquidity. If you want to buy an asset, you need someone to sell it to you. You are therefore looking for liquidity. The same things applies if you are a seller, you are looking for a buyer to take the asset you wish to sell. A bid is a limit order to buy an asset at a specific price (better than the current market rate) and an offer is a limit order to sell an asset at the determined price (better than the current market rate). Bids and offers make liquidity in a market, they provide it to participants which trade via market orders.
Liquidity is a very imporant factor in trading, especially for large traders. The more liquid a market is, the more it will attract other traders. Large traders cannot simply think about how much price will move, but also how they will get out of their trade when the time has come. This is not a problem for us retail trader, but definitely a key factor for those trading big amounts of money.
Type of Orders
Market orders
Market orders consume liquidity provided by limit orders. They are orders issued to buy/sell a specific asset at the current market price. A buy market order will be filled against the best offer and a sell market order will be filled versus the best bid availaible. Market orders take away liquidity from the market as the participant that issues them wants to trade immediately and eats availaible liquidity via limit orders.
Limit orders
Limit orders provide liquidity because they give other traders the option to trade against them. If I issue a 1 million bid (buy limit order) at 1.31000 for EUR/USD, I provide liquidity to other participants looking to sell at the market at this price. They are called limit orders because they cannot be filled at a price worse than specified. This means my bid at 1.31000 can be filled AT or BELOW (positive slippage) the rate, but not above.
Order books or DOMs (Depth of Market) are mostly used in Futures trading, as the FX market has no aggregated volume data. Example:
In this asset, we have no orders at 44 and 45, which means you can currently buy at 46 (the best availaible offer) and sell at 43 (the best availaible bid). If I decide 45 is a good price to sell at and issue an offer at that rate, the spread will narrow and buyers will be able to buy from me at 45 the amount I offer to sell. Let’s say there is an impatient buyer that moves his bids to 44. He will again reduce the spread and now sellers are able to sell at a better price than before. The order book looks now like this:
How Price Changes
Scenario 1: Trader „A“ buys 20 contracts of the asset at the market. The order book above shows the availaible liquidity and it is visible that he will not be filled at 45 as there is insufficient liquidity. He will get filled as follows: 10 at 45, 8 at 46 and 2 at 47. As he consumed ALL liquidity at 45 and 46, the order book will now look like this:
The order book will stay this way until there are new bids created below 47 OR there is even more buying at the market price (at the best offer) which drives price higher and further consumes offers.
DOMs are not used in FX (or at least, shouldn’t be used, as there is no aggregated volume data for FX), but the mechanism of price change is the same in all markets. Limit orders are providing liquidity, while market orders are consuming them.
Stop Orders
Stop orders are orders to buy above the current market price/sell below the current market price. The term „stop order“ is used because the order is „stopped“ from being executed until it hits the determined price. It is being stopped because otherwise, if you create a bid at the price where offers already exist or above, it would become marketable order and would be executed immediately.
Most of the time, a buy stop order will be executed when it’s price has hit the market „offer price“ and a sell stop order will be triggered when it’s price has hit the market „bid“ price. They will be converted into market orders and will consume liquidity.
But there is something unique about stop orders. They can also provide liquidity. Let’s say I’m a large trader looking to sell an asset (please forget about the above order book for this example). Market price is currently 44/46 (I can buy at 46 and sell at 44). I don’t want to sell at 44 because liquidity is not good enough for the amount of contracts I intend to sell. I’m aware that there are a lot of buy stops above the price of 50 from participants that are already short.
Other participants are also aware of this and price will be attracted to those levels. I will therefore set my offers above 50 (let’s say 51 and 52) and gain advantage from the stops. How? Chances are good there are not many buyers at those levels, as price will be perceived as high and liquidity is a bit thin. But there are forced buyers above 50 and they will have to take my liquidity. My shorts will be filled and price is likely to move quickly in my favor as most buying came from shorts that were stopped out. Price is not attractive for buyers and will likely drop quickly.
Stop hunting is a common activity in ALL markets, not just the FX market. Retail traders are aware of this, but mostly in the wrong way. I’m not talking about your retail broker widening spreads to take some few more stops out, but stop hunting on a larger scale. Large traders need it for liquidity as above described and bank dealers will also use it also to control their book better. But let’s leave that for later…
I hope this article gave you some good insights about the three common order types used in trading and how price changes.
As a side note: English is not my first language, so I apologize for any errors. I do my best to write understandable. 
- Ben
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Very interesting indeed. Not likely to start using this stuff yet but is definitely an eye opener into how the markets work. Looking forwards to further reading, many thanks.
Ben,
Very informative article mate. :57: Your English is very good. Looking forward to more articles.
Happy trading.
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Hi Ben,
Thank you for your efforts to teach us.
I find, ‘Stop orders also provide liquidity’ is bit confusing
Could you please explain me with an example - if possible with a screenshot image
if DOMs are not used in FX, will it be hard to predict the order flow in FX ?
Regards,
Vijai
Hi Vijai,
To answer you first question: Stops are not [U]technically[/U] providing liquidity, but in an indirect way. Let’s again take the above mentioned example. I’m looking to sell an asset which is currently at 44/46 (I can sell at 44 and buy at 46). I do not find this a good rate to sell at, so I will issue a limit order. I know there are stops above 50 and those will likely get the attention of predatory traders which will push price into the direction of stops. I therefore issue two a sell limit order at 51 and 52. Let’s assume sentiment for the asset is rather mixed and there are not many bulls. With this, there likely won’t be any buyers at 51 and 52 and price will not even reach those levels. But with the buy stops above 50 we have [U]forced buyers[/U]. Those traders determined that they want to get out of their short position at those rates and their demand will accelerate the move and trigger my offers. I provided liquidity to them, but I exploited the weaker side of the market and got into a position at a better rate. Without the forced buyers, they likely wouldn’t get trigered at all.
I will cover the topic of stop hunting later seperately, but I hope this made it more clear for you.
Regarding your second question: You do not need the DOM to predict order flow. Even if you have the DOM for i.e. futures, it shows you only orders for the upper and lower five price levels and with those markets being so liquid and fast-changing, you won’t be able to extract any useful information from it. I used the DOM above to visually explain the process of price change. I will cover the topic of projecting future flow also at a later point. 
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I studied Market Microstructure so long, I tend to forget to keep it simple when explaining it to others. If there were any parts that are not clear in the previous articles, feel free to ask, I will be happy to answer them.
Next article will be about liquidity…
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Hi Dali,
Great post! However something keeps me confused and I hope you help to clear things up a bit. This is sort of technical question, hope you dont mind explaining the basis to newbies.
In your post, you mentioned ‘’ Those traders determined that they want to get out of their short position at those rates and their demand will accelerate the move and trigger my offers…’’. who are you referring to as those traders and what type of market mechanism is happening when getting out of short position will trigger your offers? Thanks.
Jack
Hi Jack,
The traders I mentioned are simply traders who, in the mentioned example, were short the asset and had their stops above 50.
There are two ways the stops can help me:
-
the presence of the stop loss orders above will attract the attention of so-called stop hunters. It can be speculators, model funds (algos) buying into short-term momentum or dealers who do it to manage their books. I will cover this activity in a later article, but the key is that a larger cluster of stop loss orders will have the attention of other traders, especially when they are near.
-
the stop loss buying that will happen above 50, will accelerate upside momentum for a short period and get my offers triggered. However, as they were forced buyers and there are little “real buyers” up here, price will quickly drop.
I may explain this better in a real market example:
GBP bias is clearly negative and we saw a sharp drop down to 150.80 on the Sunday opening. As price declined, there were traders who lowered their stops to protect their gains and in general, more buy stops were building above. It is a common practice of retail traders (but not only them) to put their stops slightly above the big figure (big figure = every 100 pip price level - i.e. 1.50, 1.51, 1.52) when they are short.
As GBP/USD recovered, first stops above 1.5150 got the attention of stop hunters and then those above 1.52. Take a look at the chart below and you will see what I described happened twice! First stops above 1.5150 were taken out and the pair traded up to 1.5160. However, up momentum disappeared and price quickly dropped below. The 1.5090 support level held and as price marched towards 1.52, stops above were in focus. Do you see what happened? Stops above 1.52 were triggered, offers were filled, little buyers left after the forced one’s were done and price dropped!
I hope that helps.
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Thanks again for teaching us . I have a question
At the time of breakout, how will you know the breakout is of forced buyers or of real(fresh) buyers?.
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Interesting thread. A lot of people cannot accept the fact that stop hunting is a common market strategy in all markets.
Exactly. It is as old as the business of speculation. And there is nothing wrong about it, it’s just traders taking advantage of the weaker side of the market.
[B][U]Stop Hunting[/U][/B]
Retail traders are generally aware of stop hunting, but have a wrong idea what it really is. It is not your retail broker slipping you for a few pips to get your stop. Those brokers do not have the size to move market in such a way!
As we covered in the previous article, large traders cannot simply accumulate or distribute a large position whenever they wish. They have to look for liquidity and stops are helping them in an indirect way, like I explained in the example above. That is why stop hunts tend to be quickly faded: The large bids or offers got filled and with the stops triggered, there are no buyers left in a buy stop-hunt scenario and no sellers in a sell stop-hunt scenario. Those bids and offers tend to stabilize the market. If there were little of them availaible as the stops get triggered, it would result into an event called a stop cascade - there is insufficient liquidity for the stop loss orders and price gets pushed into the next area of large stops until bids/offers in good size appear.
There are also traders that anticipate such moves and look to take profit near the level where stops are rumored to be. Those are mostly short-term speculators and model funds (which buy/sell on momentum). They will take advantage of the forced buyers/sellers and liquididate their position as price hits into the stops. We will cover the topic of [U]how to identify levels of concentrated stop loss orders[/U] later.
Dealers also participate in this activity. While there are looking to make some profit from short-term trading, their main task is to provide clients with liquidity and get them filled with less as possible slippage. Let’s go through a scenario:
EUR/USD is trading at 1.3050 and Dealer “A” sees many of his clients have buy stop orders from 1.3100 up to 1.3110. This means those clients want to get out of their position once price breaks above the determined rate. If he does nothing and waits for price to break above 1.31, he will have trouble filling his clients without slippage. There will be stops from other market participants above 1.31 and other dealers will be acting similar, pushing price higher fast. He would fill his clients at a bad rate, earn nothing from it and his reputation would be seriously hit if this would happen several times.
So what can he do? He can gradually start to accumulate a long position and anticipate a break of 1.31 into the stops. Dealers tend to have a great feeling for short-term moves and are skilled for having “a feel for the market”. If he gradually buys EUR/USD all the way up to 1.31, he will be able to fill his clients without slippage and will make a nice profit from it.
More detailed example:
DEALERS ORDER BOOK:
Buy Stops from 1.3100 - 1.3110 worth $100 million
DEALERS ACTION:
Buy 20 million @ 1.3060
Buy 20 million @ 1.3075
Buy 20 million @ 1.3080
Buy 20 million @ 1.3085
Buy 20 million @ 1.3090
Net position = Long 100 milion @ 1.3079
So he will distribute his position as price breaks above 1.31 and fill his customers stop loss orders.
This can of course go wrong if price fails to maintain the upside momentum and turns lower. The dealer must then quickly get out of his position. But again, those traders are skilled at managing their positions and while they can’t be right all the time, like other traders cannot too, they have a good feel for the short-term moves.
Graphical examples are perhaps easier to understand, so I will pick an example this week and post it in the thread.
Good luck trading
How to Use Order Flow Information
Again, banks do not open their order books directly to just any outsider, one would need good connections. So people claiming they have some software that shows the order books for the FX market are scammers. As volume is not concentrated and FX is an OTC market, there is no real ‘Depth of Market’ for the whole market. The one you maybe see in your trading platform is only the DOM of your broker and retail brokers have a small role in this huge market.
However, discretionary flow information is something different. There are a few sites that provide this information for free and I’ve been using them long enough to tell they are quite reliable. Those are people that have some connections in the trading industry, mostly as they worked as traders too in the past. One needs to distinguish between discretionary information like shown below and people claiming to have DOM’s for the FX market.
Flow information often looks like this:
Example:
EUR/USD
Bids at 1.30, 1.2980, 1.2950
Offers at 1.3080, 1.31, 1.3120
Buy stops above 1.31
Sell stops below 1.30
So again, bids are limit orders to buy at a determined price. Bids mentioned in the flow info providers will be levels where good buying interest is noted.
Offers are limit orders to sell at a determined price. The mentioned Offers will be where decent selling interest is noted.
Market participants always look for the weaker side of the market, so both buy and sell stops will be targeted. Be aware that you shouldn’t just enter a trade and “gun for the stops”. You need to have other factors that support your trade idea.
When using this, it is very important to keep in mind that this is additional information that may help you in your trading, but you should not trade off this information alone - that is, using them as trade signals.
A few reasons:
[ul]
[li]Orders get cancelled all the time.
[/li][li]We cannot know the size of the mentioned orders. E.g. if there is a lot of demand for EUR/USD and rather small offers ahead, it will absorb those rather easy and continue to move up.
[/li][li]If price stops after hitting the cluster of orders, it is not a sign that it will reverse immediately. Watch for additional signals.
[/li][/ul]
Price action and sentiment comes first! There are always bids and offers, smaller and large ones, but in the end it depends on the power of the bulls or the bears. As I mentioned, if there is strong demand for EUR/USD, offers will do little on the way up until the accumulation has finished.
How to Use This Information
First, determine the current sentiment. Example: The market bias for the Pound is currently very negative and GBP/USD is clearly trading in a downtrend. I therefore will only look for opportunities to sell the pair.
Second, note key price levels. These include bids and offers from the resources I will post below and key technical levels (standard support/resistance levels).
Third, watch for price action to give you a high probability opportunity to enter short. I will cover later some of the various Order Flow techniques I learnt from Darkstar. For now, I just want to note that you should always use flow information like bids and offers with caution. You want the market bias to be in your favor and wait to see a reaction to those levels, not enter ahead.
I hope I have emphasized enough how important it is not to use them as trade signals, so I will post now the resources I use for the flow information (they are free):
Forex News | Currency News by ForexLive
https://twitter.com/OrderFlowForex
The Thomson Reuters IFR feed also includes good flow information and Oanda offers it for free to clients. If you dont have access to it, dont worry, there is enough info from the free sources. The subscription from Reuters costs something like $150 a month, which is way too much and definitely not worth the price, especially for retail traders.
Not much participation so far, if I don’t explain something clear enough, let me know. Feel free to ask anything about Order Flow Trading.
Next topic is about identifying cluster of stop loss orders in the market and what to do with them. Should be very interesting topic for OFT newbies. 
real interesting stuff Dali!
I actually prompt me to read more of darkstar material and see the way market in other aspect. I have a few quetions tho, from those links you provided above, is there any reliable source where you can get info on the bids and offer placed? Like how darkstar tweeted in his page, i wonder how he got his resources from…and do you trade with news impact as well?
Jack
I think it was mentioned in Darkstar’s members-only forum that the info is mostly from the Thomson Reuters feed and a service that specializes in providing flow information, but I think the name was not mentioned.
I’ve followed it for some time and the info seems to be pretty accurate when comparing to price action.
I usually don’t trade the news, but when I do, I trade only AFTER the news release. There will be quite often stop hunting going on after news releases and if I feel the reaction is exaggerated (especially if it goes against the current market bias) I look to fade it. One example is the recent GBP rally after the better than expected PMI data.
Let me know if you have any other questions Jack