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How to read Orderflow

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The name of our website (de.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.

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 favor.
  • 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? he 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. n 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).

  • 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.
  • e 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, lets 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 does not move. This means that limit orders stop the market orders. Do you remember what we discussed above? The market orders should “eat” the limit orders to exceed a level. But the market gets into “stuttering” when there are too many limit orders that stand in the way.
  • The disappearance of buyers/sellers. A significant reduction in limit orders at a certain price level.
  • Aggressive ones occur on the opposite side. A significant increase in market orders opposed to the local movement at a certain price level.
  • Ranges. price level, which attracted a larger number of traders.
  • Rollback. price levels at which no one wanted to trade. Rollback. Correction movements against the current trend.

The following examples show you what these movements look like for different instruments of analysis.

Footprint examples.

The Footprints is a unique instrumentthat is easy to read in real-time mode. It displays the order flow not only with numbers, but also with colors. There are more than 25 footprint types in ATAS and every trader can find exactly what they are looking for.

Here is an example in the E-mini S&P 500 Futures (ESU9) Range Chart (4). Such charts are not time tied, and are excellent at filtering out the market noise. See Figure 2.

  • We have marked the absorption with point 1. The volume of bid’s and ASK’s in the selected cells is much higher than in all previous bars, but the price is practically not moving.
  • Note the delta that we have marked with the number 2. The delta with the wick tells us a story in which the buyers were very interested in moving the price further, but the sellers resisted them. At first, limit sales orders did not allow the price to rise, then aggressive market sales orders appeared and pushed the price down. The sellers were aggressive for a short time. Probably serious players wanted to get confirmation that price growth has stopped and there are no traders who want to buy.
  • We have marked the bar where there are only 22 market purchase orders at the top – compare it with the quantity at the time of the price increase – 614, 932, 786, with the 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 graphic. The price reaches a new high, while the delta does not because no one wants to buy.

Examples with the delta and cumulative delta

Let’s look carefully at the delta and consider another example in the same E-mini S&P 500 Futures (ESU9) Range Chart (4).

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

  • We have marked the first local price high with point 1. Some sellers showed up there, but not many, while the buyers did not disappear.
  • And no one wanted to buy at the very high level of point 2 – only 48 market purchase orders.

The cumulative delta works better in less volatile markets and shows the current trend and the trend reversal very clearly. The cumulative delta is not read so well in very volatile (e.g. oil) markets.

Let’s look at an example in the tick chart E-mini S&P 500 Futures (ESU9) (2000). Also these charts are not time tied – a new bar will be built as soon as 2,000 trades are registered.

In addition to the cumulative delta, we have expanded the chart by the ZigZag per indicator, which changes direction every 15 ticks. ZigZag pro can be called in for an additional confirmation of a turnaround.

In this case, we look at the overall picture of the day. The price gradually moved downwards and the cumulative delta shows a turn in point 3. Take a long position with this signal if you are an aggressive trader. Cautious traders want additional confirmation signals:

  • Admission of buyers – we have marked the actual origin of buyers with point 1. The maximum volume has been on the upward wave since the beginning of the trading session.
  • Disappearance of sellers – we 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 have been created from point 3 to point 4. If you are a cautious trader, go into position after this rollback.

Smart Dom, Smart Tape and Spread Tape

The main difference between the DOM and the footprint chart is that DOM displays intentions (limit orders). Intentions are often deceptive and confuse beginners.

The Smart Tape shows Market Orders. The spread tape shows volume and delta when there is a spread change. When we combine these three instruments, we do not get an explosive mixture, but an excellent variant of the analysis of price movement in real-time mode.

Let’s look at an example of the Moscow Stock Exchange Index Futures (MXU9).

First, a few words about the chart legend.

  • The red rectangles in the DOM are round price levels.
  • L1, L2 and L3 are the stages of gradual expansion of the day’s low during a trading session. In other words, the price first broke the low (L), reached the low1 (L1) and then rolled back. Then it broke Low1 (L1) and so on. Every trader sets these and other signs for himself.
  • We have marked the Smart DOM price level, at which a particularly large number of trades, with the number 1. We were interested in this level after seeing big new purchases on the tape. The open interest is growing, which means that these are new positions and not the closure of old positions.
  • Number 3 marks the price level at which the dealers bought.
  • The delta, which grew by about 100 contracts, we marked with 2. We calculate from top to bottom – from the previous to the later time. At first glance, the new purchases should push up the price. But not in this case.

We have a very useful column in the tape – Up Tick & Down Tick – marked with the number 4. Ideally, when traders buy, we see + or more +++ in this column. When traders sell, we see – or several —- in this column. But when — see purchases, it works like a divergence. That is, traders buy, but the price does not move higher, but lower. If we see many subsequent minus signs when buying in the green area, it is bad. It’s a red light for buyers. It is a primitive explanation and it should not be used mechanically.

In this example, we look at a combination of factors:

  • Occurrence of new purchase orders – we see it in the OI growth;
  • Cumulation of new purchase orders at about the same price level – we see it from the delta increase;
  • Lack of price increase on purchases and even some reduction – we see it at Up Tick & Down Tick.

We come to the conclusion that we want to sell at this price. This is because new purchase orders hit the upper limit and cannot break them. Sooner or later, traders would recognize this and begin to withdraw from long positions. As soon as the time comes, we should see a strong downward movement.

The result is shown in the following table.

The price fell from 280,925 to 280,450. The Delta was 263 at 6:02 p.m. and it was 148 at 6:43 p.m. Probably these are these unhappy buyers.

This beautiful story with absorption and delta works even better at daytime highs and lows. Just to make one thing clear – not a single strategy or approach works in 100 of the cases, so always use an intelligent stop.

Volume Profiles Example

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

To better understand what we’re talking about, let’s look at the Five-Year Treasury Note Futures (ZFU9) Chart and Smart DOM.

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

We see a strong acceleration and a change of profile steps in the moments of the eruption – red arrows 4 and 5. The narrower a balanced area is, the faster an eruption would occur. It is very profitable to trade these outbreaks as a risk is less than a possible profit. The Range Breakout Trades are called Initiative Trades.

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

Conclusion

To trade profitably, you need:

  • Knowing to understand why prices stop;
  • The knowledge and practice of seeing (and not just looking at the chart) what is actually happening on the market in real time.

ATAS components simplify market analysis and help you understand the market more easily. You don’t have to predict what the market will do in a week, a month or a year. Earn money here and now – just join the dominant market players.

Download the free trial of ATAS now.
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