Lessons from the Pros

Specialty Skills

Knowing the Order Flow is Critical to Your Trading

Tom was waiting patiently… at first. Then as time went by, one hour turned into four… and he had not made a trade. His emotional balance turned to instability as his patience withered and anxiety began to creep in. Then it happened. On the two-minute chart of the ES a “blast-off” candle appeared. His heart jumped because he had been nursing a long bias, but hadn’t seen a set-up from his strategy list.  Actually, this wasn’t on his set-up list either, but he became excited anyway.   The price action continued on the 5 minute chart, then the 15, and it kept going.  By the 30 minute chart he was beside himself with what Greenspan termed, “irrational exuberance.”  Yes, the price action was going up, but Tom hadn’t seen it coming and it didn’t fit his strategic criterion or his trade plan, so the excitement was not in his best interest.  To Tom’s credit, he actually commented to himself that it was not in his plan and thus he couldn’t trade what had become an extended intra-day rally…he said to himself; “I don’t chase trades.”  Just then, a phantom hand grabbed Tom’s hand, took it to his mouse and clicked the buy button; as he heard the “order filled” alert verify that he had in fact bought into this rally.  Almost instantly, the price action hit a significant supply level and retraced immediately, soon hitting his stop-loss and taking him out for a loss.  Tom had become another novice statistic, he became distracted by emotions that were stemming from his unconscious thought; “…I’ve got to get in on this, it has money written all over it.”  He had become seduced by an illusion as the herd was buying; unfortunately, he was among the last buyers at that level which left a predominant number of sellers causing the price action to tumble.  Tom was on the wrong side of the order flow!

The market exists because of the conflict between buyers and sellers.  In each transaction there can only be one winner; the other must lose.  It is impossible for both sides to be right and the order flow goes in only 2 directions, up or down. Even in a sideways market, when you look closely, you’ll notice that the tick or pip for the most part goes up, then down, which only means that there are equal numbers of buyers and sellers at each price point.  So, the importance of knowing the order flow can’t be overstated.  At some juncture both winner and loser must close their positions.  They must at some point exit to turn a debit/credit into a case settlement.  Actually, a large percentage of price action is characterized by stops being hit or in other words the loser is liquidating.  Only the loser must get out, the winner can wait.  When the loser and winner leave the market; the market is vulnerable to a reversal – only winners are left.  All price action is determined by an imbalance of orders overtime.  How and when those orders are filled creates price action.

Your order must be ahead of the next wave of order-flow in the direction of the price action.  One hundred percent of your market study must be designed to find where the eventual loser will be placing his orders, as you analyze this, nothing else matters. Where is the loser now and to when will he exit?

Price action is about pain or pleasure.  Price action begins in the mind of every trader just as she decides to make a play.  She has enough conviction in making that trade to put herself at risk.  She believes (if she is trading according to a plan) and hopes (if she is not following a plan) that she will make a profit; otherwise, she would not make the trade.  The question is, “What creates that belief, and what happens when, due to the failure of her decision, she must change that belief?”  If you are wrong and price moves against you, for the novice trader there is pain.  When the pain is strong enough, you will get out.  Pain takes place as soon as there is realization that the internal conflict between the desire to make money and the fact that the trade is in the wrong place has been made.  Pain is directly proportional to the momentum of price action and the degree of real estate or space from the entry.  As it moves away from your losing entry, the pain grows until you liquidate and leave the market. If the winner has done the same, there are less people in the market, but only one thing is certain: only the winner can afford to wait to liquidate as time goes on. Even if prices stop moving against the loser, his pain grows, because he thinks to himself, “The trade is not working. I can’t wait anymore.”  The conflict of price action is also driven by pressure, buying and selling.

The order flow comes in natural imbalance, and this imbalance, becomes the price action.  Knowing where the loser is in the order flow is all that you need to concern yourself with when you trade:  “Where is the loser and when will he quit?”  What does this mean?  Well, you start the process of understanding where the loser is and when he will quit by first understanding what prevents you from seeing where the loser is.  This is difficult for many traders because they fail to realize that as a novice they are the loser at this point. In many ways, your thinking is the same as every other loser out there.  Knowing how you think gives you clues to how they think. You can then learn to separate yourself from the herd.  Of course, to know how you think you must first become aware of your biases as it relates to the charts and the news.  Extended rallies or sell-offs hold an inordinate amount of bias as the novice becomes exited by the real estate being covered in the price action.  He becomes seduced by the belief that prices are going to continue and often he impulsively executes in the direction of the rally or sell-off.  Actually, the seasoned successful trader is looking to take the opposite side of that novice trade when markets are extended and there is a distinct imbalance between supply and demand.  You not only need to become aware of your beliefs about the price movement, you also must learn how to look at the charts to identify areas where the imbalance is greatest because that’s where the lure of false buy or sell signals are.

The market is only a neutral organic representation of the price action; the pain is not created by, nor is it in, the market. It is only in the head of the trader.  Additionally, even though the conflict between buyers and sellers is inherently adversarial the real fight lies elsewhere.  There are those who would like to think that the market is “against them,” and that it is somehow a fight, but the fight is really with yourself.  The fight with yourself is caused by another conflict, the conflict inside the trader in the form of limiting beliefs that drive unconscious conversations regarding internal bias about price action.  These biases and limiting beliefs are about “good” news versus “bad” news, the need to conform to the movement of the masses and the belief that indicators have real time data.  These biases and limiting beliefs distort your judgment and distract your thinking.

How do you identify your thinking?  By examining your thoughts as you look at charts and by understanding what common trader illusions are.

  1.  That opportunities exist when everyone is jumping onto the bandwagon…thinking that because so many are getting in, it must mean that this is the right place to follow, usually after an extended rally.
  2. That good news means prices are going up, and will continue to go up; or that bad news means that prices are going down, and will continue to go down.
  3. And, that indicators have “real-time” information, which is valuable when determining the likelihood of price action reversals.

Understanding order flow offers the ability to enter trades early, or wait for just the right moment as a reversal is setting up.  Mastering your mental game means becoming aware of mechanical data; that is, the data of the market, technical analysis and price action and getting the knowledge about supply/demand levels.  Additionally, Mastering the Mental Game means becoming aware of internal data; that is the T+E+B=R formula where T=thought, E=emotion, B=behavior and R=results.  All of your results stem from that formula and in order to get different results you must change your thinking, which is prompted by beliefs, and which initiate emotions, that drive behavior.  In Mastering the Mental Game you’ll learn how to become aware of your limiting beliefs and actually change them in order to support bringing your “A” Game to your platform.  With your “A” Game firmly entrenched you are then in a much better position to avoid the herd mentality and thus take advantage of supply/demand rule based trading without being seduced by illusions stemming from limiting beliefs. Ask your Online Trading Academy Educational Counselor for more information.  Also, get my book, “From Pain to Profit: Secrets of the Peak Performance Trader.”

Happy Trading

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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