The Eternal Quest For The Market Bottom!
It goes without saying that as of writing, the markets are extremely volatile. The long-term picture is one of moving upwards for years with just a couple of significant pullbacks. Now we can see the supply chain being hit by hard Coronavirus fears and the markets have sold off hard.
But, not that hard!
We’ve really just taken back the gains since October 2019 in a 10 year bull run. 4 months of gains. If you consider that we moved up from 666 to 3400 on the S&P 500 Futures with only 1 major correction in 10 years, then going back to October 2019 prices doesn’t sound that bad.
What I’ve found really interesting during this move down is the amount of pundits calling for the bottom of the move. In fact, since the 3rd day of the sell-off, there’s been articles from trading educators and mainstream news sites on the various data points from previous “Big Moves Down” that they then used to predict the end of this one.
Some were using percentages “the last time the market moved down x% was at these times, then it did y” or number of consecutive down days “last time we had z number of down days, the market had a big move up”.
Interesting – but guess what? On those previous occasions, we weren’t facing a global pandemic that (regardless of the actual health implications) was doing a pretty good job of closing down the global supply chain. So why would those statistics be relevant to what’s going on right now? It’s uncharted territory.
The problem with this train of thought is that it reinforces the idea that the best thing to do when the market is moving down is to look for buying opportunities. You’ll likely see a lot of buying today too – by people thinking they have missed out on low prices.
But what could the next few months look like? What if Coronavirus reaches every State in the US and every part of every country on the planet? It’s not unlikely. What if in a few months, we are just toughing it out? Have we really just seen the best prices available considering that scenario?
I sincerely hope that those buying yesterday were right. For me though, I just don’t feel that we just witnessed bargain prices yet. This 10 year grind up has really been about too much money sloshing around and not being able to find a home.
Get into your head that the market has hit the bottom, then you start to feel like you missed out when it moves up. That’s a great recipe for entering in a really poor spot and having the volatility take you out over & over again. For most traders, this simply isn’t the sort of volatility they fare well in. Taking a few days off while it calms down is much better than explaining to your partner why you need to top up your trading account again.
So for those of you going into today with only 1 side on your mind, especially day traders. Pick your spot, play what’s in front of your face, don’t suddenly try to play “market predictor” just because the News and the Pundits have put you in that frame of mind. You probably weren’t playing “guess where the day ends” 2 weeks ago and you don’t need to do it today either.
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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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