Introduction to Order Flow Trading (Course Preview)

— This is a preview of just a portion of the content included in our new Forex Trading Course. To find out more or purchase the course, click here

This article is an introduction to applying an Order Flow approach using the Metastock platform (find out more about Metastock here). This is a very simple technique that can prove very powerful. The key to this approach is to follow the big players, choosing the right side of the market. This requires the use of professional trading platforms and a very good datafeed.

This importance of this datafeed cannot be over-emphasized: it is impossible to apply Order Flow strategies with a poor data provider, as this will twist market reality and provide false signals. The majority of newbies usually use the Metatrader platform with data, as brokers typically provide these, but it’s definitely worth switching to a professional platform such as Metastock or Ninjatrader in order to perform pro analysis.

To begin with, the technical tools that are required for this approach are as follows:

  •  Psych indicator (pink line)
  •  OBV (blue line)
  •  Linear Regression of OBV (white line)

Below is daily chart of cable (GBPUSD) with a specific setup:

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To briefly introduce each indicator:

  • Psych Indicator is simply looking at open and close prices and typically looks at continual trends. This simply plays on trend following, based on very basic psychological theory.
  • On Balance Volume is registering the number of orders in the market. It gives a good idea of volume, flow and net position, and essentially proxies tick volume. The trick with this is that a high-end platform and really detailed price feeds are required to get this to work well. All trading platforms provide OBV but it is only a profitable tool when it is supported by an excellent data feed.
  • Basic regression of the OBV allows traders to tell with a quick glance at the screen whether orders are trending up or down, and slowing down or accelerating.

So, why is Metastock useful for this strategy? The main reason is that using this platform allows traders to study the order books of banks. Exploiting this powerful information makes it possible to follow the flow of banks and create positions in the same direction as banks. The chart below shows an order book on the Euro:

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To briefly summarise how these tools can be applied to provide trading signals:

  • Psych provides buy signals when it crosses above its 50 value, and gives a sell signal when it crosses below its 5 value.
  •  Linear Regression of OBV provides a buy signal when it goes above its 0 value, while it provides sell signals when it falls below its 0 value.
  • On Balance Volume does not provide buy/sell signals, but its direction helps traders to identify and then follow banks’ flow.

The best way to explain these indicators’ behavior is to study an example. Below is a daily chart of EURUSD on last 6 months:

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At the beginning of May, there are short patterns on EURUSD. The Linear Regression of OBV fell below its 0 line, giving a short signal; and Psych confirmed this short signal by going below its 50 line. Remember that Linear Regression of OBV can provide signals, but these signals must be confirmed by Psych before taking a position. The market situation is also confirmed here by the OBV (shown by the blue line) as this began to decrease, suggesting a bearish flow by the banks.

The exit occurred on 2nd June, when Psych crossed above its 50 line, providing an exit signal. This exit would mean an increase of 277 pips or about 2%.

To sum up this strategy, a long position should be opened when Linear Regression of OBV and Psych are respectively above their 0 and 50 line, while a short position can be opened if they are below these points. Linear Regression of OBV can indicate a long or short signal despite the fact that this will require confirmation by the Psych signal. Furthermore, Psych indicators work well as open and exit signals.

Below is a daily chart of EURUSD with signals shown since the beginning of May. A short position, which was opened at 1.3620 on the 15th July, is still in place.

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In this example, notice how the OBV (the blue line) has continued to decrease since the beginning of May, which highlights the strength of the bears. This means that short signals should be favoured over long ones, as they are likely to be far more profitable.

This approach can be applied to all timeframes, from monthly to intraday charts. However, it is important for traders to remember to change the parameters of the indicators. For a daily timeframe, 5 periods of 1 trading week will work, while for an intraday chart, 15 periods of 30 minutes works well.

Below is a 30 minutes chart of cable that clearly shows the choppy market of the classical middle August period. Absence of flow can also be easily recognized in the last 3 days.

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To sum up, following the flow of the banks is key to this trading approach. The strategy which has been outlined above is a very good starting point, but it can also be improved by applying other tools such as entry and exit strategies or reversal strategies, which will be covered in due course.

— This is a preview of just a portion of the content included in our new Forex Trading Course. To find out more or purchase the course, click here