Pursuant to my last post, I will be providing market related commentary as well as thoughtful trading related discussions. What I would like to cover here today is a way to use the market's order flow to help time entries and exits.
This of course is not trading/investment advice and as you know, you can lose your ass trading futures so be careful! Anyway, I thought I would quickly go over this past Friday's action in Crude Oil to walk through the some helpful ways to view what the market is telling you.
Before I go into this, I want to quickly cover the Numbers Bars in Sierra Chart (aka Footprint) tool that shows the market's underlying order flow. I've been using this tool for many years and from what I've seen, there is a lot of nonsense and misconceptions out there regarding the uses of it (footprint/numbers bars). What I mean by that is people are using this in a myopic setting that does not allow for viewing the important information the market is telling them. An example is someone using a small period setting for the charting interval. This is probably the most naive thing to do and all it will do is confuse you. Of course, if you're a scalper looking for a few ticks here and there, that's different and this discussion really isn't for you.
Let's talk about gauging volume and order flow. A lot of large order flow is algorithmic and measured on time along with other elements such as VWAP, etc. Ever notice the spike in activity on a new 30 minute bar period? With that said, we know large volume moves the markets. So, what would be the most logical way to view that order flow? My best answer is by viewing the market's order flow in 30 minute periods. This allows for a clearer perspective of the volume transacting relative to the algorithmic time constraint benchmarks and for the volume to build with very little overlap. When using small chart settings, you will have major overlap and this dilutes the information.
Understanding order type behavior and how they can be viewed in the order flow.
There are two order type behaviors that need to be known. The first is aggressive and the second is passive. Aggressive orders are market orders in that the participant wants an immediate fill whether it be entering or exiting their position. Passive behavior can be seen in the form of limit orders and iceberg orders. The participant in this case is only willing to be filled at a specific price level(s).
There are two order type behaviors that need to be known. The first is aggressive and the second is passive. Aggressive orders are market orders in that the participant wants an immediate fill whether it be entering or exiting their position. Passive behavior can be seen in the form of limit orders and iceberg orders. The participant in this case is only willing to be filled at a specific price level(s).
How can these be seen in the order flow? First, order flow should be looked at diagonally. Meaning measuring the volume on the bid vs. the offer. If price is moving up with large volume printing on the offer and very little on the bid, that simply means that there are aggressive buyers lifting the offer.
Is this the case all the time? If large volume is for example, filling at the bid, does that mean there are aggressive sellers pushing the market? Not always and this is where viewing the passive activity comes in. As I mentioned, passive activity comes in the form of specific prices being filled. If there are a lot of market participants that plan to have orders filled around the same level, it too, creates an imbalance. When this occurs, it can be termed as absorption where there are more buyers vs. sellers that want to fill at that level. This can be an entry or exit into a position but the imbalance is creating a floor in the case of sellers hitting the bid into an area where there is an imbalance of passive buyers which results in the move lower to stop and reverse. I like to term this as "passive flooring" which is the opposite of "passive capping" where there would be more sellers although passive than aggressive buyers. Make sense?
Now that has been covered, let's take a look at Friday's action and how the order flow was very helpful in guiding realistic trade expectations. By the way, this is by no means a lesson on how to trade and I won't go into that.
I've provided two screenshots of the day's action with notes pointing to the pertinent information. The first chart below is where we can see the market opening and establishing its initial balance.
The context in this scenario is that the pit session (Regular Trading Hours/RTH) opened below the previous session's range. In market profile terms, that can be considered a gap and/or an open out of range. In these types of scenarios, the most important thing we want to do here is watch to see what the market's response will be. Will there be initiative or responsive activity?
As noted on the chart, we had responsive buying come in and push price back into the previous session's range. The order flow showed aggressive buyers lifting the offer very quickly without much seller response. Once this occurred, the expectation then is for the market to test the previous session's other extreme (previous high) to see if there are sellers.
So the trade idea for the day was to participate on the long side and capture the range from extreme to extreme. The market is showing signs of balance and we want to lean on those extremes. A long entry made sense on the market pulling back to the previous session's low where passive buyers absorbed all the "naive" shorts that jumped in without the market ever testing the other extreme. As noted on the chart, the cumulative delta for the pit open was very strong and above any sort of threshold extreme thus showing a strong buyer imbalance. It is imperative to go with that until that imbalance changes.
Once the trade was on, we would want to continue to monitor the order flow and look for signs of exhaustion and selling/liquidation coming in at our target area. On the chart below, we can see that very clearly. We see large churn volume coupled with a compression of the 30 minute bar's range. Then the next bar finally makes its way to the target area and delta shows signs of liquidation. We can see passive seller activity in the order flow at our target area. This should be confirmation to take off risk and if leaving anything on, make sure the market doesn't take out the previous bar's low. Once that happened, the trade was done and the market confirmed that the overall balanced state is in tact.
All of this can be seen very clearly on the charts provided. The trick is learning how to see it occur in real-time which I can tell you, takes a while. But its worth the time and effort. Anyway, I hope this has been helpful for you.
**Warning: Redistribution or copying of this content is strictly prohibited without our expressed written consent. This is not investment/trading advice. Trading in futures and options involves substantial risk. You may lose more than your initial investment.**
No comments:
Post a Comment