I know there have been threads about trading off of the orderbook and reading orderflow before but it seemed like they never really got in depth. I realize most of you think that with all the black boxes/quant systems, etc in our markets today reading the orderbook is a joke. Well I am not an extremely wise person on the subject but I have been watching the orderbook constantly and I believe it is a big part of my MODEST success. There are very few "nevers" and "always" in this business. There are lots of "frequently", "sometimes", "hardly" and "maybe". So I don't expect everything to always work but there has got to be some high probability situations out there. The reason for me starting this thread is to share with others what I have found to be true when reading order flow and also to be able to benifit from the knowledge other veteran traders have found to be benificial in reading flow.
Now anything I say that you think is wrong or needs adjusting please feel free to share. Like I said I am a newbie when it comes to this type of trading and am just sharing some of my thoughts about orderflow. From what I understand there are 2 main types of orders. Orders from locals and paper. Locals are large independent traders that usually trade big volume and are known liquidity providers in a market. Paper can be anything from guys like pimco and goldman to large hedge funds. They are usually the longer term players that come into the market to buy or sell in large quantities for longer term trades. From what I understand you want to be trading with the paper not against it. The thing I have yet to find out is how can you tell the difference between paper and locals? One way that I thought of would be to look at the bids/offers. Since locals are liquidity providers and usually (I think) trade the opposite of paper and fade large moves they should be sitting on the bids/offers and not giving up edge. When every tick counts they don't want to give up edge so I could find it entirely possible that most locals are making the bid/offer and not taking the bid/offer. While on the other side the paper which is usually longer term does not want to mess around with giving up a tick or two and just wants to get the order filled and move on. In that case it only makes since that most of the paper are just taking the market at the bid/offer. Now if this is true we should be able to have a rough idea of where bigger locals are at and what paper is doing.
Like I said locals are in it for the short term so say the market is rallying hard and paper is just buying as much as they can. Locals meanwhile are selling into the rally and continuing to sit on offers. Now say we are running up to an area on the book that has massive offers and it also is a level on our chart. We can imagine that these big offers are probably big locals trying their damndest to stop this rally and are going all out to shut it down. Say paper is extremely strong though and instead of running out of steam the paper is eating through these large offers in fairly decent size chunks. We finally break through all the offers and are on a run away again. Now all of a sudden you see tons of contracts just being puked as market orders. This imo has to be the locals that have been caught short and now are scrambling to get the hell out. Now what I think is that if you see a move like this happening and you can somehow someway figure out what the average risk appitite of those bigger locals are you will be able to see when they are getting squeezed like that and about ready to puke there position at the market. Something to think about
The next thing is how big is the order? This has been brought up before but it imo holds true. The market tends to always trade towards size. That means if there is an order on the book that sticks out like a sore thumb more often than not the market will try to move to that order. One person said this is because when that big order appears scalpers tend to run to that order and try to lean on the size. This causes a short term liquidity problem and we start moving towards that big size. Take it for what its worth but im not sure I believe that entirely. I think the main reason is that the market wants to move to that level to make sure its an actual order and not a spoof. Once the market moves to that level it wont take much before it either pulls and we go through it or it acts as a support/resistance level and we start trading away from it. If you see a large order like this watch as the market trades towards it. Is it increasing in size, does it disappear, does it stay the same, does it weaken? These are all things to keep in mind to try to figure out if the order is real or not. Once the market reaches the order does it start to "eat" through it or does it act as a support/resistance. If paper starts to eat through it with size look for a break in that direction. If it doesn't look to ambitious to eat through the order watch for the market to bounce off the order.
The next area is to find out where is the paper giving up most of its edge? In other words which is being hit more the bid or the offer and how aggressive are those market orders? This is telling us people are not willing to wait around and hope to get filled on the bid/offer and instead are just taking the bid/offer. The nice thing about actually looking at the transactions that are taking place on the bid/offer is that they can not be manipulated like the bid/offer. Its easy to place a 2000 lot order on the bid and pull it right away but you cant just buy 2000 contracts and then cancel it lol! Looking at the bid/offer transactions can also give you a good idea of the tempo of the market. Is it fast paced or slow paced? Are the offer transactions aggressive and the bid transactions less aggressive or the opposite?
These are just some things that I have found to be true when trading orderflow but im sure this is just the tip of the iceberg! Anybody else have any suggestions, comments, things to add to this thread? Thanks YT
The acv ratio's of the order book can be useful at times but I think you will find the cumulative delta much more useful for spotting good entry opportunities. When you find price and the delta of volume diverging, it is a good time to look for entry signals with what ever method you use.
TradeEStar Thanks for the advice but could you explain more about what you mean? What is the acv ratio and where can I find it? If I remember right you trade fixed income.....maybe eurex products? I myself just started trading the bund, bobl and schatz but most of my trading is in the schatz. If you do trade any of these markets could you help me out with what to look for when trading off of flow? Thanks a lot YT
Another thing I just thought of while trading the schatz. If paper is mixed trade with the locals and if paper is directional trade with the paper. I am really starting to get a handle on where some of these bigger locals risk tolerance is at (at least I think ). Remember there are only two people that can get screwed. Paper or locals. You just have to figure out which one is dumber in the particular situation. Learning more everyday YT
Some locals sell Paper for the IB's just to conceal prop punts so not sure you'll find an easy answer trying to distinguish either - and theres the flipper runoffs spoofing all over the place - but good luck nonetheless. cheers K