Trading The Crash
As of writing, it’s the afternoon in Asia and early morning US. All markets are continuing to sink, following the drop on Thursday and Friday. The Nikkei is down 12% on the day and the Kospi (Korea) is down almost 9% and circuit breakers kicked in to halt trading. Stocks are sinking to around January levels. Money is moving to Bonds and Gold. Certain currencies are rallying – like the Japanese Yen – which worsens their situation and puts them in a sticky situation recovery-wise.
The US markets are down too.
So how do we handle a day like today?
Well – certainly – you can’t handle it like a normal day. What works on ‘normal’ days will not work today if this continues into the US market open. The action will NOT be the same. Guessing the direction is one thing. There’s a pretty good chance the US markets will continue to slide as we open. Still – that does not mean you’ll automatically make money shorting the market…
From an index futures perspective, we’ve dropped a hundred or so points on the S&P500 Future. The underlying market (stock market) is closed. If the futures don’t recover before 9:30 EST, then the first thing the market has to do is re-align the stocks and futures. This will likely mostly be done in the pre-market. Anyway – on days when the Futures move a lot, I always avoid the open as this ‘unfinished business’ needs to be resolved. Stocks obviously won’t open at Friday’s closing prices and to me – I just don’t want to be involved in early trading simply because I’ve found this situation to be a tough trade.
After that – if the markets do take a dive, then there is obviously opportunity to the downside. You might head into a day like this thinking that it’s an easy short. The problem though when this stuff occurs, is the market rarely goes down in a straight line. There will be pullbacks and they are likely to be big. It’s going to whipsaw around a lot. Using your ‘normal’ stop size is almost guaranteed to cause a loss. I believe it’s better to scale into positions on days like this. Starting small building some buffer and gradually building your position.
In addition to this, there is a very real chance of a sudden escalation of tensions in the Middle East at any time. People already have the jitters about the markets and any poor economic data is likely to exacerbate that. So keep an eye on the economic news but also keep an eye out for any political or central bank comments about the markets/economy – for example – we might hear mention of interest rate cuts which should be bullish. Also – keep an eye on the news from the Middle East – if there is a serious escalation, it is likely to hit the market hard.
There are arguments for and against trading on days like this. On the one hand – it’s risky. On the other hand, our job as traders is to capitalize on the opportunity the market provides. Some days are low-opportunity days. A day like this is one of the higher opportunity days BUT hand-in-hand with that is higher risk. All days are definitely not equal in terms of the ability to make/lose money.
Either way – it’s good to get experience in days like this, so even if you don’t trade it – it’s not a terrible idea to SIM trade it and get to know the personality of a day like this so you can be more confident to trade it next time.
Try to not lose your pants, people!
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Order Flow itself is simply information. Just like charts, it can be used in a number of ways, some good and some bad. But let's first break down order flow into it's components so we all agree what we are talking about:
Order Executions/Tape Reading - This aspect is the real flow of orders. It's the information we see in Time & Sales, Footprint Charts, Cumulative Delta. It is looking at market orders, either as they execute or historically. I guess this is the "true order flow". Every trade is a buy and a sell. We look at market orders because we consider them to be more aggressive. When someone trades with a market orders, they are giving up a price to get an instant fill. Limit orders on the other hand just lazily sit there waiting for a market order to hit them. Often these are market makers with no directional conviction. So we see market orders as being more significant.
But we don't use these in isolation.
Volume Profile/Positions - The tape reading part helps us assess various things like momentum, traders getting stuck, balance of trade BUT the volume profile helps us understand where people are positioned and likely to get stopped out. I sometimes call this "Order Flew". It's important to know when trades will be "washed out" - for example - if we have a volume cluster on the S&P500 Futures and the market moves up 100 points and back down to it, it's unlikely short term traders on either side that were positioned there will still be there. But recent, nearby volume helps us assess areas of positions.
Market Depth - The bids and offers, the lazy passive orders waiting to be hit. This is part of the story but in terms of overall importance, I'd put it at around 20% at most. For example - if you return to the high of the day on any market, the offers will be quite large directly above the high. It means nothing at all. It's just a quirk of the market. It does not help you tell if a price will hold. On the other hand, if you see large depth and as we approach it, we see more added to the depth in front of that price, it means others are front running that depth and that is a useful bit of information.
This is the key - it is all just information. Just like price charts are information. When people look at Order Flow, they consider it to be a technique more than a set of information. They look for things like iceberg orders and decide to make a one rule trading system to fade every iceberg, For these people - yes, order flow trading is overrated because they are trying to ignore everything else going on in the markets and construct a trading system a chimp could execute.
For those looking to improve a decent trading approach, the best thing to focus on in Order Flow is momentum. Once you can read momentum you can:
- Avoid getting into positions when momentum is against you.
- Confirm trades are working after entry when momentum goes your way.
- Exit trades in profit when momentum fades.
That's perhaps the easiest way to use order flow because momentum is easier to read. It's about the market continuing to do what it's already doing. On the other hand, reading a turn in the market with order flow takes a higher level of skill and a little longer to learn.
Order flow can't put lipstick on a pig. It won't help you 'improve' something that doesn't work anyway, which is why whenever someone calls me, the first thing I ask is what they are currently doing and we discuss whether they need a reset or whether it will actually help.
When Jigsaw started back in 2011 - we were one of the first in the space and certainly had the best education. It was always going to attract the underbelly of the trading education/tools world and now we see stuff out there that is so complex but so impressive and futuristic that new traders are drawn to it like moths to a flame.
So here's my advice when looking at Order Flow
- Order Flow can't improve something that doesn't work.
- Order Flow can be used on it's own, without charts to enter and exit the market but you also have to be able to recognize different market states that need different/altered setups. There is nothing magical about this.
- Don't start jumping at shadows and take 50 trades an hour in your first week looking at Order Flow, be selective. It can be exciting to see cause and effect play out in front of you for the first time but don't overtrade.
- Do drills to learn how to read it before you trade it.
- Markets can only go up and down. Don't overcomplicate it. If you have too many Order Flow tools on your screen - you will not be able to make consistent decisions. Less is more.
- Take time to choose a market with a pace you like. Interest rates might send you to sleep, the DAX might give you a heart attack.
It is hard to see how a set of information could be overrated. It is true that some methods of presenting this information are better than others. It is also true that some people simply get on better with different tools (e.g. Footprint vs DOM).
There's a middle ground between complexity and simplicity that will leave you making consistent decisions where you improve over time. For those people, Order Flow will be way underrated because they will be the one's getting the most out of it.
Those that jump in with both feet on day one and those that have 100 different tools up, for those, it's a painful experience.
Keep it simple and manageable. Start with momentum reading and build from there. You will never look back.
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