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Order Flow Analysis: Revealing Market Sentiment Like Never Before

Welcome to the visionary charting practice known as order flow analysis. The purpose of this primer is to deliver an "a-ha" moment

that can start you on a path to trading success. It is intended to explain why traditional time-based indicators put retail traders like you at a disadvantage, and why reading order flow and volume build at price improves the probability of a winning trade. Whether you trade futures, currencies, stocks or other instruments, order flow analysis is used to determine which side buyers or sellers

is winning the market auction, based upon the volume and flow of orders being executed (the "print"). Knowing this information is

critical for determining whether price will move in the direction you anticipate.

The primer provides a first step into discovering how this remarkable shift in trading approach can change your trading outcomes. We'll explain the following:

The problem with stationary, time-based data indicators

How order flow data provides context for price movement

Why reading volume at price is critical to trading success

You may never need to look at traditional indicators again.

Part 1: Order Flow

The Problem With Time-Based Indicators

. Part 1: Order Flow The Problem With Time-Based Indicators For the first century of market

For the first century of market trading, participants had limited information from which to base trade decisions. Only price, time and historical volume data were provided for each trading session. Price action was depicted by the open, high, low and close (OHLC) price levels from the previous session. Traders were left without the ability to see what was going on in the trading pits (the market auction) by the moment. They traded using a historical perspective.

Over the years, this limited information has been used to create hundreds of technical indicators that attempt to inform brokers and retail traders of what may happen to price in the future. Because of their dependence upon past behavior, these indicators provide only a snapshot, a stationary view, of market activity. Unfortunately, the snapshot view has become an antiquated approach to trading. Retail traders have been missing out on critical information.

Rather than aggregating the millions of data points that reveal the underlying truth behind the price movement, the trading industry has accepted this restricted approach for three reasons: (1) OHLC has until recently been the only data that could be efficiently delivered to the retail traders; (2) there is an obvious simplicity to using less data (data sets would have to be organized into a logical set of variables, and that can be an overwhelming task); (3) historically, markets were location- and participant-specific domestic rather than global so a day or time series report of domestic participants' activity was sufficient for most traders.

Before trading moved into the 21 st century, the reliance upon the OHLC for the development of charting indicators was appropriate because it provided a logical view of the best data one could access at the time. However, the four-point rendering is now like using

a 64kb modem to connect to the Internet. It is insufficient. Just as a low resolution image doesn't print clearly on paper with too few

data points to give you a clear picture, utilizing four data points of a trading series to forecast future movement is blurry at best. Critical contextual information is missing.

Order Flow Analysis Provides Context

As electronic trading became available, it changed the market auction forever in three significant ways. First, the digital systems put an "electronic veil" between traders. Second, it drove higher levels of data collection. Third, the transition connected global traders with direct access to markets and better tools for analysis.

Rapid advances in data transmission and collection over the past eight years now makes every tick of data available in real time to all traders. But despite advances in electronic trading technology, many traders have still experienced obvious disadvantages. The electronic veil has limited retail traders to only price action and time-based volume. Consequently, because they were still missing the rich, contextual data beneath price movement, those traders have been forced to be the laggards in price movement.

In order to provide a vastly more effective approach for trading, order flow analysis was developed by D.B. Vaello. As a result of years practicing this visionary trading style, he engineered a software solution that depicts time and sales data (delivered in real


Order Flow Analysis: Revealing Market Sentiment Like Never Before

time) in customizable visualizations. How does an order flow analytic solution make a difference? By focusing on the observation of actual market auction orders and the volume distribution at price levels the contextual information that underpins price movement.

Without this information, a trader is left to speculate whether a price level will be hit based upon price data from previous periods. There is too much real-time data available to rely on such an antiquated, limited data-point system. Every auction is different; therefore, in order to gain context for a movement in price, and to have more conviction about whether price will move to an anticipated level, you should view the auction in real time.

The Market Auction at a Glance

The market auction is the mechanism that represents what buyers and sellers are trying to accomplish (which price action alone does not fully reveal). How committed are buyers to moving price higher? When will sellers relent and allow buyers to do so? Or will sellers be successful in moving prices lower? Market auction data reveals the volume of orders flowing in from buyers and sellers, which can then indicate the level of conviction to move price that each side has at a specific point in time at specific price levels.

This is an important piece of information to have because it gives a trader an indication of how the market feels about current price levels. Market sentiment cannot clearly be determined with the use of a stationary price indicator; it is best revealed through order flow analysis.

Keep in mind that there are only two ways a trade can happen at every market auction:

only two ways a trade can happen at every market auction: Either a buyer moves to

Either a buyer moves to accept a seller's offer or a seller moves to accept a buyer's bid.

Trades will be either struck into the bid or into the offer; consequently, price movement flows in the desired direction of the buyers or the sellers. Price doesn't move without enough conviction by one side or the other.

move without enough conviction by one side or the other. If one side has sufficient conviction

If one side has sufficient conviction and is able to move price then a market bias appears and a trend may develop. Alternatively, if one side is showing conviction but cannot move price then the other side is likely to assemble greater conviction and take prices in the opposite direction. The beauty of order flow analysis is that it reveals market conviction prior to price movement.

Looking at the image at left, you can see the depth of market around 12.00.The auction has resting orders on both sides. Based upon DOM, buyers and sellers are split relatively equally as to whether they think price will go up or down. In order for price to move to 13.00, 1734 contracts must be struck at the offer. Conversely, 1619 trades at the bid must be triggered to move price to 11.00. By focusing on the way orders are struck as time moves forward, traders get a better sense of whether price will move to 13.00 or 11.00. This is the kind of context that order flow analysis provides which price-based charting alone does not.

But even the DOM only tells part of the auction story. The only orders that will be most important to you are the trades that get triggered the print. Those orders are what indicate which side is winning. And it is that data which provides the basis for order flow analytics visualizations.

The key takeaway here is that the market activity not simply market price reveals the sentiment and, more notably, the conviction of traders. Knowing this helps to inform you of whether the market will move price in the direction you anticipate. Unfortunately, trader conviction cannot be revealed through traditional stationary indicators. Effectively trading into the right side of the bias can only be accomplished with real-time order flow data and advanced tools like the Order Flow Analytics charting solution.


Order Flow Analysis: Revealing Market Sentiment Like Never Before

Part 2: Volume

Profiling Trade Volume

In addition to analyzing order flow to confirm market moves, there is another important component for order flow traders to follow:

volume at price. Traditionally, traders have used time-based aggregations of volume to identify active instruments (liquid markets). But typical volume histograms tell nothing about where volume is being traded. Wouldn't it be more effective to use the volume of trades struck at each price level to make trade decisions? The truth is volume at price rendered through a volume profile tells you much more about current market sentiment.


Either buyers or sellers will often be in control, and volume will rise and retreat as price moves through different price levels. Some participants will trade at a certain price level and others who will prefer to hold on to inventory until price moves in an anticipated direction. A volume profile is used to identify areas that traders see as fair value and will therefore look to trade at those levels.

Institutional traders use a volume profile as a means of determining entry and exit points. They are seeking higher liquidity opportunities, so as trading moves away from fair value, volume tends to dry up. Fewer institutional trades are executed. When trade volume dries up, experienced traders are sitting on the sidelines looking for the next rise in volume. Knowing where this is happening can be crucial to making an effective trade decision.

volume profile can be thought of as a depiction of trader emotions like fear, greed, optimism and pessimism along with behavioral

attributes such as herd mentality. Support and resistance, for instance, are zones which form essentially because of human

emotions. Fear and greed have a strong impact on support and resistance levels. For example, as price falls back to a support level, traders who are already long will often add to positions; traders who are short will frequently buy to cover because they are afraid of losing money. Herd mentality is revealed because traders tend to congregate near support and resistance levels, increasing volume

at nearby levels and creating high volume areas.

Volume Profile and Trade Decisions

So, how does analyzing volume structure help in making trade decisions? Well, auction activity is often under a kind of gravitational pull toward high volume areas (HVA). Traders tend to gravitate toward HVAs over and over throughout the trading session, whether prices are rising or falling. The market often bounces right over low volume areas because there’s not much gravitational pull at those price levels. Instead, price moves to where the volume is more robust. Using a volume profile, you are better able to target your trades for HVAs.

profile, you are better able to target your trades for HVAs. Volume can be tricky to

Volume can be tricky to decipher. Algorithm trading and high-frequency trades executed over microseconds have an impact on trade volume throughout a session. Instead of seeking fair price, some institutional traders may be on a stop run, where they unwind

inventory through multiple levels of limit orders that are waiting to be filled. But analyzing volume at price is critical to targeting, risk management and profit taking because you are looking at more accurate representation of market liquidity for an instrument. Higher volume

at price means greater liquidity and better order execution. Therefore, HVAs provide

greater opportunities to enter or exit a position successfully; conversely, low volume areas (LVA) provide limited opportunities.

Price levels where HVAs (or "high-volume nodes") have formed reflect levels where the smart money is trading, and often represent key levels of support and resistance. Support and resistance zones are areas where the market tends to probe and rotate price before breaking out to form a new support or resistance level. These levels may provide an excellent opportunity to make a trade.

Conversely, LVAs show price levels where the market is not interested. Therefore, if buyers or sellers aren't willing to engage at a certain level, volume will have to push price in one direction or another before they will jump in. This creates the probe-and-rotation cycles that provide great trading opportunities.


Order Flow Analysis: Revealing Market Sentiment Like Never Before

OFA Toolkit Visualizes Fluid Market Movement

The Order Flow Analytics™ chart visualization solution was designed and built to reveal the modern tick-by-tick electronic auction and provide you with the tools to interpret where volume is coming into the market and from which side. If you are not learning how to leverage this incredible data through this visualization toolkit, you are not seeing what is actually happening between buyers and sellers before price moves, and you are trading with superficial information (price). You are at an unfair disadvantage against professional traders.

Will sellers relent and allow buyers to push prices higher? Will buyers soften and allow sellers to drive prices down? Without Order Flow Analytics, there is no way of knowing before price moves which side might be expected to win or whether a trend or reversal is coming. The visualizations delivered through the OFA toolkit allow a trader to become more patient and more successful by improving targeting, risk management and profit-taking tactics.


Hopefully, this primer has given you an "a-ha" moment and will lead you to adopting order flow analysis as part of your trading strategy. The good news is: order flow analysis is no more complicated than traditional chart interpretation. There is a learning curve, but help is available.

One popular way traders are using order flow is to confirm that a price-based decision is supported by the auction activity and market bias. Are you in need of a better price confirmation tool? As with any endeavor, greater success comes from greater clarity in trading. This can only be offered through an order flow analytics solution. We hope you now have a clearer understanding of order flow analysis and why it can improve your trading results.

Click here for more information about getting ahead of the market. Stop relying on antiquated, stationary trading tools of yesterday. Join order flow analytics pioneer D.B. Vaello and become an order flow trader.

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