ES Trade with a Shake-Out!

Published on: October 29, 2013

I got emailed the link to a new YouTube channel last week whilst I was on vacation and I took a look around today.

You can see the channel here – http://www.youtube.com/channel/UCfTf7NJsGKh8U-4svZfz1zA/videos – the videos are well edited with audio and callouts, making them very easy to absorb.

I’d like to take a look at his latest video – “ES Minor Reversal” – because, well – I like to trade minor reversals on the ES as anyone who watches my webinars will know. As usual – for best results use Full HD, Full Screen mode.

I’d like to add my own comments about the video on top of what is already there:

1:00-> The volume profile is showing a very even distribution with a step below @ 54.50 where you have 40k traded and then 20k traded at the next price down. You also have 49k traded at 1755.

At this point (as we can’t see what occurred earlier), we can assume that 54.50 has been defended and that 55.00 with the high volume might also be a line in the sand with 54.50 as the major point of no return. Any lower than 54.50 and you are probably going to see some acceleration to the downside.

As the bid for 2 lots goes in @ 55.25, we have stacked bids which to me would be indicative of a bit of spoofing BUT bids are always stacked at the lows and with the step in the profile @ 54.50, that actually makes that level a low.

So – I’d be wary of those bids but all lows tend to look like this so after a fill, I’d want to see those bids stay firm and them to follow any move up.

1:22-> We get the fill, some of the bids are gone and some size is coming in on the sell side. Still – we are above the step @54.50….

1:33-> Where you see the “I got scared by the big boys selling”. At this point those large orders did push it down to 55.25 and that is still our inside bid. What we’d like to see now is those guys getting caught offside. We have good bids but not stupidly large fake bids, so it doesn’t look like a flip being set up. The sizeable bids are at 54.50 and 54.75.

2:00-> We come down to 54.75 and just 56 trade this time. Then we tick up off the back of 3 large trades. At that point, those shorts at 55.50, 55.25 and 55.00 are in trouble. Buyers were there at 54.75 more or less at a point of resistance (on the volume profile).

As we move up, we can see that decent bids follow price up and large trades hit.

Nice reversal, shame about getting shaken out.

This trader isn’t using the volume profile but is using another method where his trendline should have been @ that level if he’d been drawing it correctly. So there’s evidently a bit of low confidence in the trade location. I’d say with a bit more confidence that there is a ‘backstop’/’level to lean on’ – he wouldn’t have felt so nervous about the location. It wasn’t a huge move against him after all.

The selling we saw had little impact and there was no follow through below. So – always think about the order flow AND the resulting action. If selling doesn’t cause price to move down – you have trapped sellers.

An excellent set of videos TS! I hope it inspires others to record their trades so that they can review them and use that as a platform for improvement.

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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.