What is Order Flow Trading? - Part 1
03/05/2014 9:00 am EST
There is a lot of confusion and dispute over what exactly order flow trading is, let alone how it can be utilized as a profitable trading method, notes Adam Lemon of DailyForex.com.
Order flow trading has a very wide definition and it is not necessarily exclusive to other methods of trading. The cornerstone of order flow trading is anticipating the prices where other traders have pending orders set, particularly important market participants with very large orders.
Obviously, order flow cannot be traded without "picking levels." This is a big reason why many traders find order flow trading too frightening or intimidating to trade: traditionally, trading gurus warn their students against picking levels, admonishing them to "trade what you see, not what you think." This seems to be good advice when you watch a chart, mentally pick levels and watch them all get blown away by the price. However, it does not have to be this way, not if you think a little more about the levels that you pick, and equally importantly, if you use tight stop losses.
Many gurus teach trading methods based upon identifying likely support and resistance levels, and watching for confirming price action when the price arrives at these levels. In a sense, this is also order flow trading, as the method is based upon expecting there to be a lot of orders at these levels. However "true" order flow traders would take it one step further and not wait for the price action confirmation before entering the trade. This seems more dangerous than waiting for price action confirmation, but think about it. If you are waiting for the close of an hourly or four hourly candle before entering, just picking the level would get you in at a much better price, putting you well in profit already by the time price action traders start to enter. Another advantage of a pure level-picking method is that you can usually use a much tighter stop than you would need following price action confirmation. Additionally, the stop would be better placed.
So, how to pick the levels? That is the million-dollar question, but in my experience, the really fruitful levels are obvious support or resistance formed at previous daily and weekly highs and lows. Order flow traders must learn not to be afraid to trade against the trend. Some of the best order flow trades you will see will be triggered by a very strong and seemingly unstoppable move in the opposite direction that is quite frightening to trade against. I will explain why this is so in tomorrow's article.
By Adam Lemon, Contributor, DailyForex.com