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What Is Order Flow Trading and What It Is Not

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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.

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.

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.

Stop Hunting

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 how to identify levels of concentrated stop loss orders 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:


Buy Stops from 1.3100 – 1.3110 worth $100 million


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.