How does Order Flow Reveal Itself?

Order flow has somehow become the buzzword of trading. It took a long time for the retail traders to begin to look at what the locals in the pits had been doing.

The pits have two broad groups of locals. One group provides much of the liquidity to the brokers filling paper by taking the other side of their trades hoping to do enough two way business to make a profit - sell retail, buy wholesale, basically fading the moves. The other broad group "goes with the flow" and even creates some of it. This second group trades in the direction of the momentum and nett orders.

There are many different reasons that trades are made in, say, the ES: a hedge against a stock position, a hedge against an option position, transferring risk, place holding, speculation, part of a complex arbitrage and so on. Some of these trades are trades that MUST be put on at certain times because of their interdependence on other transactions, some of these transactions MUST be put on at specific price levels, some of these trades are reactive against certain price movements, some of these trades take place when certain market activity takes place and so on.

So the environment that we are trading in is a very complex one with many different types of market participants with many different time frames and motivation.

When we trade, we try and synthesize this into just one trader - is he buying or selling. However, because of the complex activity - ES can trade 3 million contracts a day - to be able to synthesize the action and determine an overall order flow, I need to look at many parts of the picture in different ways. Information from just one bar in isolation is meaningless. The relative activity of the bars tells a story as does the volume that is traded. These are the only two pieces of information the market gives us. We then take this data and mine information from it. How we organise and extract data from the price and volume activity is crucial to our success because we must draw a conclusion from the information we have. If we organise the information incorrectly and rely on that information then the conclusions we draw will be incorrect.

This may sound obvious but I'm talking about it again as many traders put things into their charts without a reason. If I have something on my chart I want it to tell me something I need to know and I want it to tell me the truth.  My interaction with my charts is a like having a spy telling me what the enemy is doing. Listening to this information is a like listening to a squawk from the floor with additional secret information being conveyed. If what is on the charts does not do this, why are they there? What is the indicator saying about order flow and momentum direction and strength? This is what matters.

Today's ES Gap trade was not on. The 45CCI was clearly showing upward momentum. CVD was buying. There were a series of bounces off the 33EMA support. The market got ahead of itself twice for a good outside in trade but the Profile showed that the market was accepting value higher up.