Lessons from the Pros

Specialty Skills

The Order Flow is All Important to Your Trading Success

Have you ever noticed the price action rising like a rocket in an extended rally or plummeting in an extended sell-off? If you’ve been trading for any length of time, the answer of course would be yes. Ahh, but the more important question is, how did you respond? If you are a novice, you probably took one look at it and thought to yourself, “Wow, look at that; I’ve got to jump in on this because it will give me a win.” Did you feel an emotional surge of say, excitement or greed? Then, what did you do? Did you hit the buy button on the rally…or the sell button on the sell-off? What happened next, in most situations, is that the price action hit a significant supply zone/resistance level or demand zone/support level and immediately retraced…more than likely, significantly. Then you lost! Either you were stopped out, or you didn’t have a stop in place and you lost so much capital that you liquidated the position. After that, you probably felt frustrated, frazzled and angry, not to mention calling yourself a few choice names. The order flow and being able to identify when it shifts and when it is about to shift is all important to your successful execution. Let’s take a closer look.

Firstly, the market exists because of conflict. For every transaction, there must be a buyer and a seller; hence, it is necessarily adversarial, and in each individual 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 two directions, up or down. So, the importance of knowing the order flow is paramount. What should be noted here as well is that many of the order flow movements are case settlements which occur when a short is covered, or a long is sold. 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 over time. How and when those orders are filled creates price action. So, what you must attend to is whether or not your order is ahead of the next wave of orders in the direction of the price action. Your analysis, if you want to be consistently successful, must be designed to find where the eventual loser will be placing his orders.

The order flow quite simply is the number of buyers and sellers that are lining up at any given price point and it is a natural imbalance. 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, 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 fact of the matter is the market is only a neutral representation of the price action; there is no pain in nor created by the market. It is only in the head of the trader. Also, there are traders who think that the market is “against them,” and that it is a fight. However, if there is a fight, it is with yourself. The fight with yourself is caused by the internal conflicts. These internal conflicts are in the form of unconscious limiting beliefs that drive thoughts about the price action and about yourself. These biases and limiting beliefs are about “good” news versus “bad” news; the need to follow the herd and the belief that indicators have real time data. It’s important to become aware of these biases and limiting beliefs by monitoring your thoughts. In other words, what are you “telling” yourself just before that impulsive entry or chasing that trade? So, examine your thoughts as you look at charts and become familiar with the common trader illusions about jumping on the bandwagon, or following indicators as though the information they contained were as reliable as the reality of the price action.

Careful tracking of the order flow offers the ability to wait for the right moment as the order flow is indicating that a reversal is setting up. Your mental game must be in order to become aware of mechanical data (the mechanics of the trade); that is, the data of the market, technical analysis and price action and getting the knowledge about supply/demand levels. Additionally, your mental game means becoming aware of internal data; that is, the thoughts and emotions that drive the behaviors which produce your results. All of your results stem from thoughts, emotions and behaviors, and in order to get different results, you must change your thinking which is driven by beliefs, which initiate emotions, which drive behavior. Trading is a precise, performance-oriented art. In order to have consistent success, you must “always” bring your “A” Game. 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.

Have a great day.

– Woody Johnson


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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