Order Flow and Trading Volume Techniques

Most traders trade price.

The truth is we all trade price. However, prices are determined by traders placing orders in the market. Those orders are what is seen on the bar and candlestick charts on our screens. Look under the surface and visualize what is taking place.

Most traders are either unaware or do not place enough emphasis on the fact that markets are moved by buying or selling shares or contracts in an individual instrument. Ultimately, supply and demand forces move price. Volume and orders move price.

Fortunately, one can use certain techniques and concepts to put order flow and trading volume on their side.

Markets are propelled through a process known as a dual auction. It is much like the auctions we are all familiar with only this process regulates price and volume in two directions. Normal auctions match buyers and sellers in an event that generally sees price work higher with multiple participants willing to purchase the auctioned item.

A dual auction involves shares and commodity contracts being bought and sold in a continuous process. This process moves price up and down in a price discovery mechanism. In a dual auction the auctioned items can come on or leave the market at any time. The unsteady supply and demand makes tracking participants intentions difficult.

One way we can get a handle on who is doing what is by tracking volume and volume patterns. Volume is how much traded at a given price or level. Volume patterns are how volume is coming into the market as price advances or declines.

Knowing how much traded gives traders a sense of participation at certain levels. That participation is opinions on value being voted on with dollars. The more dollars, the stronger the opinion. Moves often originate from levels where there is too much participation after an already directional move.

In the example, one minute E-mini S&P futures, we can see the over participation after a directional move.

order flow and trading volume

This is on a short timeframe but the point is well illustrated. Too many participants leaning in one direction creates a possible vacuum on the opposite side. Lots of traders who sell in the same place or the same price at the end of a move creates unusual volume. When enough people buy or sell, that may be the end of the move. Nobody wants to trade in that direction anymore. They now need to seek orders on the opposite side to extract themselves from a bad position.

Likewise, selling or buying drying up well into a move can signal the lack of enthusiasm for continuation and an imminent reversal. This time traders built positions over the length of the move. As the price worked its way downward, traders became less interested for whatever reason. The realization became evident that mostly anyone who wanted to be short was. A two- way market ensued, buyers and sellers reached equilibrium. The forces just decided that the price needed to move up to facilitate trade.

order flow and trading volume

The patterns repeat over and over. The market moves on positions being taken, order flow.

When order flow becomes too heavy, after a move, everyone who wants to buy or sell have already done so. Traders are now trapped with no new orders to let them out. The market pauses or reverses.

When the market moves far enough, buyers or sellers become disinterested at the new levels. The market stalls and pauses or will reverse.

Again, the market is a dual auction process always searching for order flow. When extremes are reached the auction trades in the opposite direction starting the process over again. Extremes and turning points happen when order flow and trading volume reaches an extreme or turns. Charts and technical tools are great, but remember what takes place when using these tools in your trading. The key is to be on the side of the dominant order flow.

Happy New Year!

Craig Garbie
Senior Futures Instructor
Market Taker Mentoring, Inc.