Retail vs Pro Day Trading 1 – Tunnel Vision

Published on: May 12, 2021

In this series, we’ll take a look at the differences between retail and professional trading. In each post, we’ll focus on one aspect where we see a major difference between the two groups. In this first one, we’ll look at the scope of decisions made to enter trades.

Obviously, there’s no ‘one size fits all’ trader on either the professional or retail side. I’ve met professional traders that follow the sloth-like queue on ultra-liquid markets. I know retail traders that thrive on the super-fast DAX and others that run from it in fear (and rightfully so).

BUT

There’s one fairly big difference that is quite endemic. On the professional side, it’s generally accepted that there are many things that can move the markets. At the lowest levels, that could be a stop run of traders offside, or recoil after a stop run. These are among many small “knee-jerks” that occur in the markets because of traders out of position. You can find pretty much universal agreement over these sorts of reactions. They are in some respects the “lowest level” reactions that generate the smallest moves. Now, you can of course use them with a bias to get in on a larger move but I am getting off track.

If you look at the opposite end of the trading spectrum, there’s more of a divergence. The biggest one being the use of News. Most retail traders stick to the adage “It’s all in the charts” and say many tell me “I don’t want to trade the news”. This is fine and my standard reply is “So how do you prevent news while you are trading?”. 

You can break the news into a number of key areas:

• Scheduled economic releases (like unemployment numbers).
• One-off scheduled meetings (e.g. EU changing a trade restriction, Fauci talking about COVID restrictions).
• One-off “out of the blue” news, like an attack on an oil refinery or rumors of interest rate changes
• Running news – like Covid or Brexit that keeps hitting the markets (usually with a semi-predictable outcome).
• ‘Mouthy’ Politicians – OK, I say this because Angela Merkel once said something ‘off the cuff’ that made a Bund trade slip 23 ticks past my stop. Trump tweets are in the same category.

In other words, some news is planned, some is not.  The news can be used in a few ways:

• To enter a position because of the expected outcome of positive/negative news. In other words to play the sentiment. That can involve going offside if the market initially doesn’t have the expected outcome.
• To play the market’s reaction to the news. This is slightly different from the above but both often involve having an expectation of how the market will react to positive or negative news. Then watching and piggy-backing the move.
• To understand whether the current move is a regular swing in the market or probably because of a recent piece of news.  This isn’t reacting to the news. It’s more of seeing a move and being aware that it may be extended/fast because of recent news.
• To stay out of the way of news completely – obviously, this is only possible with planned news.

Now, there are arguments for NOT using news. One of them is the “Efficient Market Hypothesis/Theory” (EMH/EMT) which states that the markets reflect all information known. If you believe in this, then consider the following:

• When employment numbers are really bad – why does it trigger a move that lasts the morning or all day?
• If a piece of news had someone like Fidelity dumping 100’s of millions of shares – would they do it in a single sell market order? 

On observation, the markets seem to take time to re-adjust to news. So I think the belief in this isn’t borne out in the real world but it does give traders an excuse to ignore a lot of stuff. 

The answer to the latter is “no” – they would try to get out without hurting prices too much. There are other times where everybody rushes to the doors (or the roof) because news is catastrophic. 

So news creates both moves and a level of urgency. At this point, it all sounds so complicated, doesn’t it? I think this is why retail traders ignore it.  There is the allure with pure chart trading that once the right combination of factors is on your chart, you can then put your brain into neutral when trading. The thought of anticipating a reaction to news is quite frightening compared to the simplicity of printing money while half asleep.

So the majority of retail traders limit the scope to what is on the charts. Professionals – will use anything that appears to have a cause and effect on the market. A good example is grain traders using weather events. 

Retailers WANT trading to be isolated to the charts – and I’ve seen people get through 20 years of trying to do that and failing. Some will stick with charts because of the “sunk cost fallacy” which means they stick with charts because of the amount of time they spent with them. Most though – they won’t start incorporating news because it seems a bit scary and a lot like a huge amount of work. After all – how do you get to the point where you can predict the way the market will react to any news.

The good news is – you don’t!

I am going to give a list of suggestions. They are not in any order. The idea is to become proficient at one thing and then add another. You cannot learn the dance between the news and the different asset classes overnight but then you don’t have to. Add one at a time:

• Pick an economic release such as the Thursday Unemployment Claims, Wednesday Oil Inventories and keep a log of the expected numbers, the actual numbers, and the reaction in the related markets. Did it go up or down and by how much? Get a feel for the sort of hit or miss that creates a move. 
• When a long-running story is in the news – Brexit, COVID, US Inflation – scan the news for announcements/press conferences for that day. Take a note of the sentiment of that news (the sky is falling/we are all saved) as well as the reaction to that news.
• Subscribe to Bloombergs “Five Things To Start Your Day” and for each news item with a time of day – write down which markets you think will react (and how), then as the news plays out, review the actuals. This may seem a bit involved but it’s giving you the chance to make a call and have a feedback loop to ensure those calls get better.
• Keep your ear on the news (with tools like the news feed in Jigsaw’s daytradr and Journalytix). When a sudden move occurs, if you missed the cause on the squawk, go back to the news screen to check out the news that probably caused it (if any). This way you get a great understanding of the amount of times news causes moves you can exploit. 

None of these represent a lot of work and they all represent ways to start to understand how news impacts markets you trade. It’s not as if you have to stop your chart work OR have to go do an economics degree for 4 years. It’s just incrementally learning factors external to your charts that may move the markets. 

Try it out, get a few wins under your belt. You’ll soon be used to accepting there’s a whole world of things that can impact markets and chart-tunnel vision isn’t in the traders best interest.

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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.