A Basic Introduction to Order Flow Trading

Order flow trading involves basing trading decisions not on price movements or fundamentals, but on the presence of other traders’ open orders within the market.

In the case of financial institutions or commercial traders, such positions can be extremely large, so having access to this information should be useful for predicting short term market moves – particularly for smaller, more agile traders.

Usually, order flow trading requires direct market access to the order book via an ECN broker and is more readily used in futures trading where orders are visible.

Predicting market direction

When looking at the order book for any liquid market there will usually be plenty of buy and sell orders on either side of the current market price.

Predicting market direction based on the order book then comes down to analysing the balance between the buy and sell orders.

For example, if there are more sell orders than buy orders the market is more likely to head downwards.

Conversely, if there are more buy orders, the market is more likely to go up. The closer the orders are to the market price, the stronger they are likely to affect the price movement.

Large orders as resistance

Typically, forex pairs will be nicely balanced on both the bid and ask, and this is a direct result of high liquidity, helped along by scalpers, day traders, and algorithmic systems.

However, very large orders in the order book can help traders predict market direction. If there is a very large order just above the market, then these orders will often act as significant resistance. Since the market will have to absorb all these sell orders in order to move past the level, the big order will help drive the market downwards.

In conjunction, short traders will try and jump in before the big order and drive the market down since they have the protection of the big order above them.

It’s exactly the same story, but in reverse, for long traders.

Fake orders

The thing to remember when watching the order flow is that open orders can be removed at any time. Because of this, it’s not uncommon for cunning traders to enter fake orders above or below the market price then remove them before they are filled.

By doing so, they can create the impression of a big order near the market or an order imbalance and that presence can help drive the market in their favored direction.

For example it you are short 1 lot in EURUSD and their is a fake 500 sell order directly above you, you are somewhat protected from upward price moves. However, if the 500 lot order is removed, the resistance is also removed and your trade protection is gone.

Because of this, it’s important to keep a close eye on the order book at all times and react accordingly to any changes.