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Trading Like A Dealer: Treasury Management With High Risk

  • Post #1
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  • First Post: Dec 18, 2014 7:40pm Dec 18, 2014 7:40pm
Hi,

I am starting this trading journal to collect my thoughts, analysis, charts, records, etc. all in one place. I have been studying and trading the FX markets for a little over 2 years. I long ago left the retail FF community in favor of the academic research/textbooks. I have a strong understanding of order flow, market microstructure, price and liquidity's interaction, momentum, crowd behavior, dealer risk management tactics, etc.

I primarily trade the 3 kingdoms (borrowed from FTI). This includes EUR/USD, GBP/USD, and USD/JPY. I also usually track one asset that is being talked about in the news because they usually have strong trends, high volatility, and offer great trading opportunities. Ideally this would currently be Light Crude Oil or Dow Jones Index, however, since my broker needs a higher margin requirement for those assets I am currently tracking emerging market currencies such as USD/RUB. Anyone is welcome to chime in with their views.

I may or may not share my trading method. Maybe I will post bits here and there. For now just know I manage my account like it's a trading book, I day trade with 1M but use all time frames to predict potential order flow, and my motto is buy low, sell high. The main focus of this thread is to track the progress of my book and a place to keep all of my analysis. These posts are mainly for me, but if you find any value or have any insights, you're more than welcome to reply. I will update this introductory post with more in depth information about my trading style later when I have time, but for now I want to go ahead and start posting analysis for the upcoming week.

-FXMasterSK
Hope all will learn something new. Thank you sharing this.
I am interested to know which broker you will be using?

Good Luck
Don't speculate trade with surety.
Quoting csubbra
Hope all will learn something new. Thank you sharing this.
Quoting KingHussain
Good Luck
Thanks for the support guys!

Quoting KingHussain
I am interested to know which broker you will be using?
I have accounts with TD Ameritrade, FXCM, and Oanda. These are regulated brokers with great reviews (from traders who actually know what they are doing) and I am very satisfied with them.

However, my goal for this account will be to take a small account and make big, consistent returns on it with high risk that fits into my position limits. The leverage restraints in the US disallows me to reach my goal in the time I want, so I am choosing an offshore broker named ForexBrokerInc. I have heard really good things about them from many different sources and have used them for a few weeks demoing. Their webtrader platform isn't too great, but MT4 seems pretty decent. On any trading day I am connected to them by MT4, webtrader, and if it ever came down to it, I have their number ready and my phone nearby.

I am only going to deposit 1/10th of my full trading capital for this account with this broker because after all they are still unregulated. The leverage they offer will easily allow me to take high risks on the account. A loss to me = blowing the account = 10% risk of my true account balance.

The best thing about them is they allow up to 1:500 leverage (I will not be using it all, but it is good to know that I won't have to face a margin call) and accept US clients. A plus is that they allow same pair hedging. This is a plus because I, like you, believe stop losses on short-term time frames are ripe for exploitation by the big players. And if your stop isn't tight, then your risk/reward ratio is all messed up. So you have two options for stops on a short time scale: 1. Know the best area to place stops that aren't too tight or too big and take the risk of it being hunted. 2. Use a mental stop loss and watch the charts or use price alerts. ForexBrokerInc's hedging factor allows me to use a different strategy to manage risk. I place buy/sell stops in the areas where I know I am on the wrong side of the market and hedge my original position. What this does is it locks in a loss at a smaller percentage. Then, I wait for the next entry signal and close out the hedge, and wait for the market to retrace. This will potentially allow me to close out my book at high returns vs. minimal to even no losses. If you are familiar with FTI (30 years dealing experience) which I believe you are, I will follow the same rescue/attack sequence as him. The difference is that my losses will be hedged rather than letting them run.

Standard risk disclaimers apply: I don't advise anyone to try this with capital you cannot afford to lose. Don't take high risks or be over leveraged on your account unless it is a secondary gambling account. Etc. etc.

PS - I will start posting analysis and ideas throughout the weekend as I get time.

-FXMasterSK
Thankyou, I will be reading your posts
Don't speculate trade with surety.

~Post-week Analysis~

Week of 12/14/14


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A good exercise for me is to see how the week panned out and matched or didn't match to my pre-week expectations. As a trader who makes trading decisions based off of 1M, 5M, 15M, etc. time scales, it is crucial for me to be on top of daily market movements, whether that means something big like central bank intervention down to something small like daily commercial transactions.
Note: I never make assumptions of what should happen and then cry when it doesn't. I trade price and the signals it spits out and position myself accordingly. Even then, I can be on the wrong side. It's all about finding a statistical edge and making more than you lose, keep your book growing.
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USD($): The dollar started the week off having a correction against some pairs like the euro and yen. This was to be expected as US data wasn't much better than expectations and there was position squaring/profit taking ahead of the high risk FOMC meeting. Pre-meeting saw some participants betting a stronger dollar. The meeting itself was a wild rollercoaster ride. Most market participants were hoping that the Fed committee would decide to remove the "considerable time" statement and replace it with "patient", which they did replace. But then, they decided to follow that up with the fact that the new statement isn't any different from the old one. This led to whipsaw price action that took out weak players on both sides. When price settled, the big players thought process was that if not invest in the strong outlook of the dollar, what else? So the dollar capped off finishing the week higher against most pairs from where it started.

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EUR(€): EUR/USD started the week off advancing, supported by economic data and position squaring. It slid down on comments made by an ECB member that the ECB is willing to do whatever it takes to support the eurozone economy. Once the madness of the FOMC meeting ended, this pair fell down sharply, and even ended the week making a new low on speculation that an all-out QE program may be launched next year.

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JPY(¥): USD/JPY saw a similar fate as E/U, starting the week off continuing a correction from the previous week. Abe's election win didn't see any dramatic effect on the pair as the yen strenghtened against the dollar. Pre-FOMC meeting flows caused the yen to start dwindling, and when price settled after the meeting, USD/JPy strenghtened. BOJ also kept their monetary policy statement relatively unchanged at record easing, finishing the week off at a weekly high for USD/JPY.

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GBP(£): The pound continues to be stuck in a range against the dollar, looking for something big to break it out. It started it's week ranging until a downtrend ensued. That downtrend was quickly eaten up and saw a high made to levels not seen since late November. Once FOMC flows came into the picture, the pound started weakening and fell sharply post-meeting. It ended its week gaining back most of the post-FOMC weakness.

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RUB(₽): Falling oil prices and the ongoing Ukraine crisis continued the collapse of the rouble. New highs were made this week as investors bought USD/RUB on dips. The rouble did get some good news near the end of the week. Brent oil prices rebounded at a $60 floor as investors squared books and took profits ahead of the year-end. This helped the rouble gain back some ground before the end of the week.

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~COT Report Analysis~

As of 12/16/14


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The COT Report shows market participant positioning in options and futures markets. This data is current up until the last Tuesday, however, it may be lagging as the report is not released until 3 days later on Friday. Still, it can be used to get an idea of of medium-term sentiment and trend exhaustion. When buying pressure is dying down in a bull market and new buyers are not replacing the old ones, we may see a swift trend reversal. Vice versa in a bear market.
Combining this with my other analysis allows me to confirm my views and tilt the odds in my favor.
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Euro FX
Long 54,329 vs. Short 176,470
Changes from 12/09 -2,745 Long vs. -13,899 Short
Position's were squared ahead of key risk events as both longs and shorts closed out positions and took profits.

Japanese Yen
Long 44,590 vs. Short 131,395
Changes from 12/09 +7,402 vs. -9,647 Short
Bets were added for longs while shorts were closed out and profits taken.

British Pound Sterling
Long 36,519 vs. Short 53,564
Changes from 12/09 +209 Long vs. -8,570 Short
A few long positions were opened while shorts were closed out.

Russian Ruble
Long 3,936 vs. Short 1,349
Changes from 12/09 -586 Long vs. -5,732 Short
Both longs and shorts were closed.

Important Note: Most of the time this data does a decent job showing medium-term sentiment and my analysis can be better and more indepth, however, I believe the data above is not very current to the market's positioning and here is why. Like I said above, this report is released on Tuesday. Wednesday was a high risk event day with the FOMC meeting. Many participants closed out their dollar longs ahead of this event and this is clearly shown in the report above. Now that the event is over and participants are back in the market, this report is not very accurate. Luckily, I don't rely heavily on this report and there are other ways to stay ontop of what is going on in the market. Use it as it was made to be a used, a tool like many other types of analysis's to tilt the odds in your favor. But you must still use your head.

~Sentiment Analysis~

Week of 12/21/14


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Sentiment plays a crucial role in my trading and is one of the key drivers of success as a trader. It is what allows you to filter the good trades from the bad, when you should trade a certain pattern and when not to, and what side of the market you should be entering. Do you really want to be buying in a bear market when the big boys whose orders move price are selling? Of course not. Sentiment can be derived from just reading the news (Reuters, Bloomberg, even FF News). Global macroeconomics plays a big role in trend direction, however, don't forget about aspects of the market such as profit-taking and position squaring, market squeezes, etc. After all, it's all about tracking money flows and what's moving the market, and capitalizing on it.
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EUR/USD

Global Macro Factors - The dollar's hot prospects and looming interest rate hikes in the horizon makes it a particularly attractive investment. The US economy has staged a broad recovery and is well on it's way to becoming one of the top growing economies at a time many other global economies are slowing down. Although falling oil prices will hit US shale drilling hard, this will also be a good thing as consumer's will have more money to spend and this could potentially help boost inflation. The eurozone, on the other hand, still faces risks of falling into deflation. A prominent ECB member has also stated that the ECB will do "whatever it takes" to keep the economy from going into deflation, launching speculation that a full blown QE package is in the works for 2015.

Bias - Bearish ↘

Opinion - With a strengthening US economy and speculation of QE by ECB, the downtrend in E/U should continue and this pair should be sold on any rallies at resistance.

USD/JPY

Global Macro Factors - Japan has long had an ongoing struggle with deflation. This led to the BOJ adopting a stimulus policy which continued relatively unchanged at the last meeting. Factoring this with the strength of the US economy paints a pretty clear picture for this pair.

Bias - Bullish ↗

Opinion - With BOJ continuing it's stimulus program and US economy strengthening, the uptrend in U/J should continue and this pair should be bought on any dips to support.

GBP/USD

Global Macro Factors - The UK has continued to see improvement in it's economy and there is speculation we may see rate hikes as early as within the next year. The only thing keeping the sterling from going higher is the strength of the US dollar.

Bias - Mixed →

Opinion - Both currencies countries have a good outlook and until further news or data shows one country clearly outperforming the other, we may continue to see a ranging market. I will be looking to buy dips, sell rallies on price action confirmation.

USD/RUB

Global Macro Factors - Although the slide in oil prices may have temporarily hit a floor, the Ukraine crisis, Russia's economic slowdown, and broad US strength should continue to weigh in on this pair.

Bias - Bullish ↗

Opinion - There is rumor that trading may continue in this pair in the next month. If that is true and the economic situation remains the same, the uptrend will most likely continue and I will look to buy this pair on dips to support.
Tomorrow I will finish up with technical analysis (the road map), fundamental analysis (knowing and preparing for upcoming market events), and reviewing any important news over the weekend that may cause a gap. I may or may not trade Asia on Sunday. Come Monday I might try to catch a piece of London and will definitely be trading the US/London overlap. My plan is to try and make this more of an interactive trading thread while I am trading, but it depends on how much time I get between trades. I'll post charts, entries, exits, all that stuff, and if anyone has any questions I will gladly answer. After every trading day I will finish with post-trade analysis. This is where I keep record of all trade entries, profit/loss percentages, book value, that sort of stuff. I'll try to post charts explaining trades I took and why. Just know it's not really easy to explain my thought process as I take into account things like herd behavior, gaps, momentum, volatility, etc. and take trades on based on instinct and gut feeling. But I will do my best and an exercise like this will most likely help me better understand areas where I should have exited and what not. That's the plan at least and we'll see how it pans out over the week. Good luck everyone!

-FXMasterSK

~Technical Analysis~

Week of 12/21/14


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Like I said above, technical analysis provides me with a road map. I can plot fibs, pivots, s/r, all that and "see" the potential resting orders there. However, you cannot trade based on that judgement alone. For me, I like to watch price approach key areas and spit out signals that it is exhausting before I enter a trade. Honestly, you don't even need to plot all of these fancy looking tools to identify key areas. A trained eye can see how price is reacting to certain levels and make trades just based on that. Nevertheless, I like to do this little exercise to identify confluence and key supply/demand zones. It helps to to keep these areas in mind and then watch how price reacts to them.

Note: Although my charts may look like a cluttered mess, the charts I actually use to enter my trades are pure naked and clean. These TA tools just end up getting in the way and distracting me from feeling the rhythm and heartbeat of the market. I do keep them in the corner though to identify where we are on the map.
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TA Tools Used:
SMA50
SMA100
SMA200
Round Psychological Levels
Fibonacci Retracements
Support/Resistance

Green indicates a demand zone I may be looking to buy at
Red indicates a supply zone I may be looking to sell at

EUR/USD:

1HR -
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Daily -
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USD/JPY:

1HR -
You can ignore the triangle. It's just a developing pattern I want to keep my eye on. For those interested: http://www.forexfactory.com/showthre...30#post4484730 and http://www.forexfactory.com/showthread.php?t=288142
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Daily -
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GBP/USD:

1HR -
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Daily -
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USD/RUB:

Since the dollar/rouble trading has been been suspended, I am not focusing much on it anymore.

~Fundamental Analysis~

Week of 12/21/14


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I do this exercise because it helps give me an idea of what events are going on in the upcoming week and what to look out for, but really all it takes is pulling up the FF calendar on your trading day and taking a quick glance at it. Fundamental analysis is important as big players look for trends in the strength of the data to invest their money in that country. A country with strong data and growing potential will see it's currency appreciate against a weaker one. For the traders (mainly day traders) that don't even care about fundamental analysis, you are blind to a key part of the market and are probably losing trades that could have easily been avoided or capitalized on. Remember the saying, "if you fail to plan, you plan to fail".
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Major Events:

12/23/14 8:30AM USD Final GDP q/q
Forecast: 4.3%
Previous: 3.9%
Likely Revision: 4.5%

The big players will definitely have their eye on this report. A reading below forecast will hurt the dollar while a reading in line or above expectations can fuel more USD strength.

Other Fundamental Reports:

12/22/14 10:00AM USD Existing Home Sales
Forecast: 5.21M
Previous: 5.26M

12/23/14 2:45AM EUR French Consumer Spending m/m
Forecast: 0.2%
Previous: -0.9%

12/23/14 4:30AM GBP Current Account
Forecast: -21.1B
Previous: -23.1B

4:30AM GBP Final GDP q/q
Forecast: 0.7%
Previous: 0.7%

12/23/14 8:30AM USD Core Durable Goods Orders m/m
Forecast: 1.1%
Previous: -1.1%

9:55AM USD Revised UoM Consumer Sentiment
Forecast: 93.5
Previous: 93.8

10:00AM USD New Home Sales
Forecast: 461k
Previous: 458k

12/24/14 All Day EUR German Bank Holiday

12/24/14 USD Unemployment Claims
Forecast: 291k
Previous: 289k

CHRISTMAS EVE

12/24/14 JPY BOJ Gov Kuroda Speaks

12/25/14 + 12/26/14 CHRISTMAS and bank holidays. Expect choppy markets and lower liquidity. No trade days for me. My brokers is closed anyways.
There hasn't been any important new news over the weekend that would affect my currency pairs. Just more articles about Sony hacking, mourning in Pakistan, US airstrikes, oil output, brutal police killing in NY, etc. Although the news is just sad and depressing, they likely won't affect FX too much. There's a small possibility of safe haven flows.

The only thing I see that could cause a gap in euro-dollar is this news that came out over the weekend: ECB's Coene supports government bond purchases

We shall see and if any opportunities present themselves I will be watching.

Now if you think this analysis is hard and a lot of work, it really isn't. Writing it out is a lot more time consuming than anything, but quickly reading over reports and news doesn't take much time and you can instantly wrap your head around it. I would usually just turn on my computer and pull up FF news and calendar and my brokers platform, and instantly start making some quick trades on the 1M TF. You might be able to find some of those old posts and charts.

That's pretty much all of my analysis for now. I'll be gone until the market opens back up to get a better idea of where we are at.

-FXMasterSK
Hello FXMasterSK,

You did really put trenmendous affort in this writing and explaining how you approach the markets, and plan ahead the markets, it clearly shows how bad you want it. From the Fundamentals view to the technical analysis. You can for sure find a job in the Financial area with such writing skills .

I am interested to see how you will manage "Hedged Trade". As for me, everytime I hedged, it was a way of non-accepting my loss and wanting to capitalize on small retracement. However as you are against the "Long-term flow" closing the hedge is extremely delicate. I prefer hitting my SL and reload at a better price (next entry area).

More importantly, I do think choosing ForexBrokerInc is not a wise choice and I seriously want to warn you against them...
--> For me, having a leverage of 1:50 is really enough, most professionnels use 1:10 and as you know Forex is a long-term run
--> They are unregulated and do not care about US Rules, just think for a second in the case you would be profitable on your account ... Do you really think they will let you withdraw your profits ???? They are not scared of US Rules, then why would they care about you ??? They certainly are a MM...

But I agree that the FIFO rules is sooo annoooyiing !!!

I wish you the best, with such organization and discipline you will become a great trader, just hope that you will keep posting here so that we can learn from you !! So hard to find poster like you !
Good luck FXMasterSK !!
  • Post #14
  • Quote
  • Edited at 7:28pm Dec 21, 2014 7:02pm | Edited at 7:28pm
Quoting ChanhXanh
Hello FXMasterSK, You did really put trenmendous affort in this writing and explaining how you approach the markets, and plan ahead the markets, it clearly shows how bad you want it. From the Fundamentals view to the technical analysis. You can for sure find a job in the Financial area with such writing skills .
Hi ChanhXanh,

Thanks for that! Hopefully I can just make money from the markets, then writing would just be a hobby lol.

Quoting ChanhXanh
I am interested to see how you will manage "Hedged Trade". As for me, everytime I hedged, it was a way of non-accepting my loss and wanting to capitalize on small retracement. However as you are against the "Long-term flow" closing the hedge is extremely delicate. I prefer hitting my SL and reload at a better price (next entry area).
You brought up some good questions. Answering them will require explaining my strategy more in depth and I'll try to give the best summary I can.

You see, I take into account a lot of things other retail traders don't. For example, volatility, average daily range, session range, etc. of my pairs. This is important because it allows me to get an idea of how much I can expect my pairs to move and what my pain threshold would be (IE how much I can take price moving against me).

Price does not just go up or down, it fluctuates, meaning it goes up and then down and then up and then down while following a directional trend (uptrend, downtrend, range). It is in the nature of many markets, especially FX, to mean revert. Now my money management has been carefully calculated to take into account the daily range and how much I can expect the pair to move on a given day. I am planning on risking 10% of my account per trade SEQUENCE. This means I don't just put all my chips into one trade and either hit a loss or win. I practice trade management like many FX dealers/funds do by adding to winners and rescuing losers. Some call this martingale, I will refer to it as a well known investment strategy known as dollar cost averaging. The reason this is better than martingale is because I enter at key areas with price action confirmation and I know why price is moving the way it is (something that can't be known just by watching charts). This allows me to know when to rescue trades and when to accept the loss. You CANNOT trade blindly when practicing this strategy. So I build positions up to keep gains large and average myself at a better price to keep losses really small. I do occasionally trade against the macro trend, BUT I do not average those trades. If I am caught against the trend I will man up and just cut my loss. But when I have positions with the trend, all I have to do is to wait for the trend to reinforce and when price comes back down I make quick money. Worst case scenario, I lose 10% of my account. Profits usually easily eat up those losses though, speaking from experience. Attacks are added until I have used up all of my attacking power or trend exhaustion signals show, in which case I cut and take my profits. Rescues are only done if my original position is a good one, but the timing was off. I learned this strategy from a poster here named FTI. He has 30+ years of marketmaking at the tier 1 Interbank level. What I wrote in a few paragraphs it takes 200 pages of reading in his thread to truly understand the logic behind it. You can find the original thread here and it does take a couple of readings: http://www.forexfactory.com/showthread.php?t=57639

Now, the reason why I don't use stops is because trading off of 1M, 5M, 15M charts they can be hunted. You have to place them at smart areas and you still risk them being hit. On the 1HR+ charts stops are a good idea especially if you don't constantly watch the charts, but for me I am usually always watching or using price alerts so there isn't a need for them. The hedging factor is just a plus that allows me to hedge bad trades at a small locked in loss until my next entry to reaverage into a better price. This just makes it so that my losses remain small and don't escalate, and if I need to bite the bullet and put the position out of it's misery, the loss will stay small vs. reward due to the fact that the loss was locked in to remain small. So now you should understand I only use hedging if needed, but I still use my head and if it comes down to it I will take my loss and move on to the next trade. When you've been trading for a while with a viable strategy, you understand losses are a part of trading and the real goal is keeping them small vs. the profits you make. That is how you keep your equity growing. Once I start trading and explaining my entries, exits, all that you will get a better idea of what I do and how I do it.

Quoting ChanhXanh
More importantly, I do think choosing ForexBrokerInc is not a wise choice and I seriously want to warn you against them... --> For me, having a leverage of 1:50 is really enough, most professionnels use 1:10 and as you know Forex is a long-term run --> They are unregulated and do not care about US Rules, just think for a second in the case you would be profitable on your account ... Do you really think they will let you withdraw your profits ???? They are not scared of US Rules, then why would they care about you ??? They certainly are a MM......
For the ForexBrokerInc thing, I'm not really worried. The reason I chose them was because I heard a lot of good things about them and they are one of the few brokers that would allow me to risk as much as I want to. I have been with them for a few weeks now testing and so far so good. I do not recommend anyone to put their full trading capital with them. I have accounts with three regulated brokers (TD Ameritrade, FXCM, and Oanda), and honestly the capital I am using for this mini account would not even put a dent into my true trading capital with the other brokers. I also use 1:50 leverage on the other brokers and don't even use all of it, but this account is just a fun account to see how much I can gain in a certain amount of time. Worst case scenario, my gambling money from my trading profits on the other accounts gets lost, but ForexBrokerInc also risks losing their reputation as I do take pictures and keep copies of everything so I would have viable proof.

Quoting ChanhXanh
But I agree that the FIFO rules is sooo annoooyiing !!!
FIFO does suck. It's supposed to protect the retail trader from losing money, but it could also be beneficial if used right lol. Whatever though, I don't worry about how things are. I just worry about how to make money.

Quoting ChanhXanh
I wish you the best, with such organization and discipline you will become a great trader, just hope that you will keep posting here so that we can learn from you !! So hard to find poster like you ! Good luck FXMasterSK !!
Thanks again Chanh. If you ever have anything to add or any more questions feel free to stop by!

-FXMasterSK
Markets are pretty boring right now. Of course I expected it, but I just wanted to see the area where we opened at (which was pretty much the same area we closed at). So in the meantime, I will re-post some of my old posts made on another (pretty dead) forum explaining some of the market structure basics. This one will be for more newer traders that have gotten past learning the real basic stuff like support/resistance, candlesticks, that sort of stuff.

-FXMasterSK

Order Flow Analysis

===========================================================================================================================================

Market microstructure basics will tell you that there is one and only one thing that causes price to change, and that is liquidity interaction with order flow. In a nutshell, my trading method involves looking at things that can cause market participants to enter orders into the market in a certain direction, as well as how greed and fear play in their trading decisions. I trade in the direction of a clear macro trend and general sentiment. I use price action for timing and finding the best area to enter, and am very selective in each trade I take. Tight stop losses are avoided and careful risk management is put in place. After that it becomes a probabilities game in which the more odds you have in your favor, the better the chance your trade will win. If its still not clear, don't worry, I will get much more in depth with this later on. For now, here is an introduction to order flow analysis:

Note - There are many other traders who trade this way, but refer to it with a different name. This is not anything I came up with myself, but learned piece by piece through other traders. I want to share what I know with newer traders because this knowledge is highly beneficial to your trading career.

What is order flow analysis?

Order flow analysis is a broad term used to describe a mindset in which the market is broken down into what it really is, an ongoing process of multiple transactions of orders resulting in the determination of price. Combining knowledge of market microstructure with the reasoning of market participants to enter the market allows order flow traders to profit by entering the market before other traders. Order flow analysis involves taking into account all the order flow generators including technical analysis, fundamental analysis, global macro, options, and other generators rather than just focusing on one. It involves positioning yourself to take advantage of future order flow which will lead to price movements. It also involves analyzing all the different variables, scenarios, emotions, market players and positioning, expectations, and other factors that can generate enough order flow to move the market. It is a different way to approach the market than the typical one taught to most traders, and also the most profitable one. Learning order flow trading leads to learning how markets operate and teaches you to be more selective in your trades, taking only the most lowest risk and highest winning probability trades.

What is order flow analysis not?

Order flow analysis is not trading from flow information directly from banks, information which is hidden from most participants. It is also not a holy grail strategy, but instead a mindset in which you can find multiple strategies that work to exploit market inefficiencies. Order flow analysis does not involve tape reading (at least in Forex trading). Nor is it another form of price action, although price action plays an integral part in reading order flow on charts. Learning this style of trading involves learning the foundation of every market, which is order flow and liquidity.

Why does order flow trading work?

Order flow trading works because it relies on actual market mechanics and dynamics rather than indicators or common chart patterns. It works because this mindset involves an understanding of what is really moving the market, what the expectations and emotions of participants are, what will cause price movement in the future, and how to profit from it because in the end, the only thing that moves price are market participants and their orders. An MA crossover or RSI at 80 will never generate sufficient order flow most times and that is why most traders lose when using these types of strategies. That is not to say that other strategies aren't profitable, but order flow traders definitely have an edge against most other traders and are always steps ahead.

Will learning about order flow trading lead to riches?

No, learning about order flow trading will not automatically make you a profitable trader, but it is one of the best ways and also the most intense way to take you to becoming a profitable trader. The holy grail is ultimately the trader, not the strategy. Only the amount of work you put in will contribute to you becoming a successful and consistent trader. If you don't stay on top of market events, the market environment, and what other traders are doing you will never achieve the potential to becoming a profitable trader. You wouldn't even truly be trading with the order flow mindset. I will try as best as I can to pave the way for you to become a successful trader, but there is no guarantee I can automatically make you successful because you must first learn something no one can teach you, the lessons learned from experience. Can trading with an order flow mindset lead to ultimate riches? Yes, but its not as easy as following certain steps. It will still require you to put in the effort to stay on top of the market and beat other market participants.

Why are orders so important?

Order flow is defined as the aggregate number of buy and sell orders being executing in the market. The role orders play in price determination and profits is huge. No matter what the market conditions currently are, only one thing moves price, and that is order flow interacting with available liquidity. The orders market participants enter create supply and demand for that particular currency, or any other security/financial instrument for that matter, in which the stronger side will overpower the weaker side. When the supply and demand is equal, price will stay the same. When demand is higher than supply, price will rise to accommodate the higher demand until more sell orders hit the market and create price equilibrium. When supply is higher than demand, price will fall to accommodate the higher supply until more buy orders enter the market and create price equilibrium. The theory behind order flow analysis is that price is determined by the aggregate order flow input by market participants, and figuring out what will create a large imbalance of order flow to a particular side and when that order flow will hit the market can allow order flow traders to profit by entering with a low-risk high win probability trade.

"Every great building starts with a solid foundation."


The Foundation - Market Microstructure Basics

Part I

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The Structure of a Trading Market

The original purpose of trading markets
When thinking about trading, many people have a belief that trading markets are something to invest in, speculate on, and make big profits or go bust due to the huge amount of risks and rewards involved in this business, but this is far from the markets original purpose. Markets were originally created to conduct business. The foreign exchange market for example, is used by international companies to exchange currencies from foreign profits they make by selling goods overseas. They must convert foreign money people paid to buy their goods into their own home currencies to pay their workers. Stocks and bonds were sold to raise money for companies and governments. Markets had a clear purpose apart from only speculating on.

The concept of liquidity
Liquidity is the ability to trade when you want and have someone else take the other side of your open position. Liquid markets are good because they have a lot of participants willing to transact with each other, creating lots of liquidity. Illiquid markets have a lot of price swings and volatility (the amount of price movement in a certain amount of time; high volatility means price is swinging around a lot, and low volatility means price is barely moving). The absence of liquidity is what creates big price movements, but liquidity is a good thing. For example, if you have a buy position open but there are no other buyers, you will have no one to sell to later on and price will go against you to induce more buyers to enter the market which may cause you to have to close your position at a loss. Although entering the market before the large illiquid price movements occur leads to your position in profit, you will still need to find someone to take the other side of your trade when you are ready to get out to avoid price going against you. Trading liquid markets and identifying when illiquid times will present themselves in the future is a great way to trade. It should be stated that experienced order flow traders can also trade the illiquid markets which have higher risk but higher profit potential because all that matters is taking advantage of future order flow and managing the risks.

Liquidity providers and takers
Liquidity can be provided by anyone, but the main liquidity providers are dealers who usually must provide liquidity or suffer consequences and hurt their reputation. Liquidity can also be taken by anyone, but the main liquidity takers are other participants apart from dealers e.g. customers. Liquidity is provided when participants enter limit orders signaling a price they are willing to transact at, and liquidity is taken away when other participants agree to transacting at that price and fill that order. Participants signal their intention to buy by setting a bid price, and provide liquidity for someone willing to sell at the same price. Participants signal their intention to sell by setting an offer/ask price, and provide liquidity for someone willing to buy at that price. That liquidity stays open unless specified until another participant takes it away by taking the other side of that trade. If liquidity is present, price will remain the same, but the lack of liquidity is ultimately what causes price movements. The type of order issued by market participants is what creates and takes away liquidity.

Types of orders and its effects on liquidity
The four most common types of orders are limit orders, market orders, stop loss orders, and take profit orders.

1. Limit orders provide liquidity by offering other participants the chance to transact at a set price. Limit orders are entered into the market and remain open unless specified until a participant agrees to trade at that price. A bid is a limit order issued to buy an amount of a security at a specified price and gives other participants the liquidity to sell at that price. When you see a bid price, it is the price you may sell at to the bid issuer. An offer is a limit order issued to sell an amount of a security at a specified price and gives other participants the liquidity to buy at that price. When you see an offer price, it is the price you may buy at from the offer issuer. Limit orders are used to transact if and only if the current market price reaches a price specified by the limit order issuer.

2. Market orders take away liquidity by offering participants the chance to instantly transact at the current market price. A buy market order will be filled against the best available offer and a sell market order will be filled against the best available bid. By taking away available buy and sell limit orders, market orders consume liquidity, yet allow participants to trade immediately. If there is no available liquidity and a market order is issued, price will rise or fall until more liquidity enters the market, causing slippage to whoever issued the market order.

3. Stop loss orders may be attached to market and limit orders as a form of protection from losses. When a trader opens a buy position, they may choose to attach a sell stop loss order in which if price falls against them too much their specified stop loss price triggers and opens a sell position to close out the original buy position at a small loss. When a trader opens a sell position, they may choose to attach a buy stop loss order in which if price rises against them too much their specified stop loss price triggers and opens a buy position to close out the original sell position at a small loss. In this sense of these stop loss orders opening new positions to close out original positions, they take away available liquidity. Setting a stop loss price doesn't mean you will automatically get out at that price because if there is no liquidity at that price, you may suffer price slippage. Stop loss orders do not have to be attached to limit or market orders and can be opened as an order on their own. A participant may choose to issue a buy stop order if they want to buy if and only if price reaches a certain number above the current market price. A participant may choose to issue a sell stop order if they want to sell if and only if price reaches a certain number below the current market price. Using buy and sell stop orders are only recommended for breakout traders who would rather use them instead of limit or market orders. Stop losses also play another very interesting role for some participants in which it provides them with liquidity and accelerates price momentum. For large participants who need a lot of liquidity, they intentionally hit large numbers of stop losses to fill their liquidity needs. For example, a large participant has a big buy position open. He knows that there are sellers at resistance with big stop losses right above that resistance. He hits the market with large buy orders, causing price to increase until he hits the buy stops of those sellers. This forces those sellers to close their position by buying and creates liquidity for the participant, allowing him to sell back to the new buyers at a big profit. If the participant didn't close his position, price would accelerate with upside momentum for a short period of time as it searches for liquidity to fill those buy stops. Most likely after that, price would drop back down since the move was forced and there were little "real" buyers left up there. That is why you may see spikes that take out your tight stop losses, only to return and go your way. Stop hunting plays a big role in trading markets and it is not the brokers trying to trick you out of your money as widely misbelieved. It involves manipulation by big capital players and is a part of how markets operate. Knowing where stops reside in mass is not hard to guess due to the spread of beliefs being given out on where you should place your stops. Large clusters of stop loss orders usually reside 5-10 pips away from major support/resistance areas. Participants are taught that keeping your stop losses tight keeps you from losing too much money, but keeping stop losses tight actually leads to your stops being hunted and executed by the bigger, smarter participants. As an order flow trader you will ultimately decide where to place your stops. I personally like to place mine a S/R level away, but each trader is different. However, knowing that most people will use tight stops allows us to form the conclusion that clusters of stop losses reside near S/R levels and even build strategies around it. We will come back and visit this rule later on and see how it can play a role in our trading decisions.

4. Take profit orders specify a price at which a participants existing position will be closed at a profit. A buy position with a take profit specified price will be closed at a price higher than the price it was bought at, and a sell position with a take profit specified price will be closed at a price lower than it was sold at. Unlike stop loss orders which can accelerate price momentum, a large amount of take profit orders can cause price to reverse. These orders can usually be found right below resistance or right above support levels, however its hard to pinpoint exactly which S/R level since every trader uses different rules.

"Every great building starts with a solid foundation."


The Foundation - Market Microstructure Basics

Part II

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Price Change and Its Reaction to Order Flow

Price equilibrium and disequilibrium
When there are an equal number of buyers and sellers transacting in the market, price will be at equilibrium due to the orders canceling out, and will react by staying constant. When there are more buyers than sellers, price will be at disequilibrium and react by rising to induce more sellers to enter the market and cover the excess demand. When there are more sellers than buyers, price will be at disequilibrium and react by falling to induce more buyers to enter the market and cover the excess supply. The aggregate number of buyers versus sellers is what determines the price the market will move to in accordance to the rules of supply and demand. This process of price discovery is constantly ongoing, and markets are always searching for liquidity and the right price to create that needed liquidity. Incidentally, price changes in accordance to orders and the participants who submit those orders. It is only market participants that create the price the market trades at with their order flow, not any event or situation. That is why a core principle of order flow analysis is studying market participants, the strategies they use, and how to exploit those strategies.

A DOM order book explanation of price discovery
Order books or DOMs (depth of market) contain inventory of bids and offers across different prices. They are mainly used in stocks and futures since the foreign exchange market has no central volume data, but price dynamics are the same across all trading markets and order books are the best example to explain the process of price discovery. Here is a simplified example of an order book:

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The current market price is 101/98 because the best offer is at 101 and the best bid is at 98. This means that you can currently buy as much as available at 101, or sell as much as available at 98. If a participant decides to issue a buy limit order (bid) of 5 lots at 99, the spread will narrow and price will move to 101/99 because of the added liquidity. This will give other participants the option to sell at a better price, and the order book now looks like this:

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The current market price is 101/99. If a participant decides to issue a market sell order for 30 lots, they will not get filled completely at 99 as there isn't enough liquidity. What will happen is price will change and the participant will face slippage. He will get filled 5 lots at 99, 7 lots at 98, and 18 lots at 97. His order is consuming available liquidity and this will be reflected in the price, which now becomes 101/97. Here is how the order book looks now:

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The current market price is 101/97. The available liquidity at 97 is now 3 lots and the participants market order caused the spread to widen by consuming liquidity that was originally available. The order book will stay this way until further transactions occur. As limit orders are added, liquidity is created and as market orders enter the market, they will consume liquidity. This whole process is reflected in the changing of price. It is a simple process, but it is complex in that markets have thousands of participants and thousands of transactions occurring daily, and the search for liquidity and price discovery is constantly ongoing as long as markets remain open. The available supply and demand for an asset is what determines the price at which it will be trading at.

The power of round numbers

In her paper, Currency Orders and Exchange Rate Dynamics: Explaining the Success of Technical Analysis, Carol L. Osler teaches us that stop-loss orders and take-profit orders tend to cluster around round numbers. This holds true because humans like simplicity. When someone asks you how much you bought your new TV for, you don't say "$896.54", you say "about $900". Humans have round number simplicity programmed into their heads and that is why their orders cluster around round numbers.

Order flow's role in causing price extensions and creating "noise"

So why are support and resistance levels not exactly formed at round numbers? This is because price change dynamics cause price to get extended from those round numbers. For example, price is at 107 and you assume it will meet resistance at 110. Price ends up pushing past 110 to 112, then falls back down creating resistance at 112 instead of 110 like you assumed. This doesn't mean you were wrong. All it may mean is that something caused enough buyer order flow to enter the market that they overpowered sellers at 110, so price extended to 112 before inducing enough sellers to exhaust those buyers and push price back down. Osler's explanation that orders cluster near round numbers is helpful because it gives us an idea of near what price participants are entering their orders and allows us to estimate future order flow on price charts. We know they won't always be respected because price extensions, due to the mechanics of liquidity, can cause price to be pushed around a little bit, but price will tend to create support/resistance levels near round numbers. This is simply how order flow and liquidity interaction work, and it also helps explain "noise" on lower time frames. Many people believe lower time frames contain a lot of "noise" and those time frames should be avoided. Support/resistance areas don't seem to be as precise as they would on 1hr and up time frames, and there is a lot of whipping price action. But this whipping price action isn't "noise", just simple market mechanics at work. "Noise" is an incorrect term because each price extension that occurs has a reason behind it; that one side of the markets order flow was stronger and caused price to extend. Experienced order flow traders can read the order flow in this "noise" and profit from it. Price gets extended more frequently on lower time frames because lower time frames contain more price action in a shorter amount of time, and takes less capital to move price around since less participants trade lower time frames. This does not advocate trading on lower time frames, but makes it clear that "noise" is just simple market mechanics at work.

"Every great building starts with a solid foundation."


The Foundation - Market Microstructure Basics

Part III

===========================================================================================================================================

The FX Market Structure

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A two-tier structure

The FX market structure is divided into a two-tier structure consisting of a dealer market and a customer market. The dealer market is on the first-tier and is called the interbank market. In the past, only FX bank dealers participated on the interbank level trading with each other. Now, anyone is able to set limit orders and provide liquidity so if they are able to meet the strict capital requirements, they may trade at the interbank level. Examples include hedge funds and brokers. It is not uncommon to see $50 million or $100 million orders passing through the interbank market in mere seconds. Although participants besides dealers can now trade in the interbank market, they only make up a small percentage of interbank market volume. Dealers still make up the biggest percentage and use it to conduct hot potato trading, a concept you will learn later on. The participants trading at the Interbank level have two trading platforms at their disposal, EBS and Reuters 3000. These platforms connect each other over the virtual interbank market and show all the prices that participants are willing to transact at. Each platform has currency pairs that are more liquid in that platform than the other, so both are used frequently. The second-tier is the customer market and includes interaction between medium and small-sized banks, retail brokers and ECNs, hedge funds, commercial companies, and retail traders. Each participant has their own reason to trade. For example, the banks may sell to commercial businesses because they can charge a fee added in the spread and profit, while the commercial businesses would be willing to buy so that they can convert overseas profit. Brokers may sell to hedge funds and retail traders because they too play market maker and charge a spread for their cost of doing business, giving them profits. The hedge fund trader might be willing to buy because he believes he has a high chance of knowing where price will head in the future is looking to invest his capital. The retail trader might be buying because he believes he made a right call and will be a millionaire in no time. These types of transactions all take place at the second-tier.

The main investment options available in the FX market

Foreign exchange participants have three main investment options when it comes to trading currencies, the spot market, the futures market, and the options market.The spot market is traded OTC (over the counter meaning there is no central exchange regulation body) and is known as the cash market, which means that the exchange rate value represents the current value of a particular currency pegged against another currency. For example, when you exchange your euros for US dollars you are participating in the spot market, and the amount of dollars you receive is derived from the spot price of EUR/USD. Currency futures contracts are traded on the CME (Chicago Mercentile Exchange) and are traded as legally binding contracts that obligate the two parties involved to trade a specified amount of a currency at a predetermined exchange rate during a specified period of time in the future, unless the holder's position is closed before the expiration time. Options are similar to futures contract, but they differ in that they are legally binding contracts that give the holder the right, but not the obligation to buy or sell a specified amount of a currency at a predetermined exchange rate anytime during the life of the contract. They are also mainly traded OTC. Currency futures contracts have no upfront costs aside from the commission charged, but currency options require that a premium be payed. Currency options are also one of the most popular ways for corporations or individuals to hedge against adverse price movements. The main difference between spot FX and futures/options is that with the latter the price is determined when the contract is signed and a delivery date is decided, usually some time in the future. With spot FX, the price is also determined when the transaction occurs, but the exchange of currencies takes place instantly or within a short period of time after the transaction is completed.

Market participants

Dealers

Dealers are the ones who allow us to trade. They facilitate our trade by taking the other side of it. Dealers like to end their trading day with zero inventory on their order books (inventory meaning the number of positions they have opened by taking the other side of their customers trades). If they believe they can profit off of positions they currently have open, they may keep it on their books. But if they consider it a bad position, they will get out as soon as possible which usually occurs in a matter of seconds. They get out by offloading it in the interbank market, trading it to another dealer who will sell it to any customers who want it and then to another dealer and so on until that whole position is offloaded to customers. This process is known as "hot potato" trading and is what gives the FX market a lot of extra daily trading volume, although it is just one position changing hands multiple times. Dealers may also use manipulation tactics such as stop hunting to manage their books. The dealers goal is to facilitate exchanges without losing, and their main profit is derived from charging a fee known as a "spread" for each transaction as a cost of doing business.

Sovereign names

Sovereign names include central banks and institutions like the Bank of International Settlements (BIS). Central banks trade to keep the market fair, balanced, and keep price from doing erratic things. They may police the market, or keep price in a range that will help their economies, but they usually only enter the market when they need to intervene. They possess vast amounts of resources to make price go their way and it would take a big psychological event to counter their order flow. Asian central banks are especially known to be heavily involved in the FX market. Central banks usually go through the BIS so their orders remain anonymous. Many participants follow what the banks do and order flow can become shifted during central bank interventions. At times, news feeds like Thomson Reuters will report rumors of central banks intervening in the market, which shouldn't affect your trading decisions unless price action confirms it. But when those news feeds report that central banks, acb's (Asian central banks), BIS, or any "Basel name" (Basel is the committee at BIS) are actually intervening, we should take this into account with our trading decisions and should only take trades if the banks are buying or selling alongside us, otherwise avoid taking trades altogether.

Large capital traders

Large capital participants include hedge funds, model funds such as algorithm and high-frequency trading funds, and other large speculators. They are profit-motivated and have a diverse variety of strategies. Some of them trade intraday while others choose long-term time frames, and others use a combination of both. Hedge funds usually look for big trending moves while model funds like to focus on automated trading and love volatility. These participants are usually leveraged and it is possible that they can get caught having their stops hunted or get stuck in market squeezes.

Real money traders

Real money participants are differentiated from other large participants because they are unleveraged. Examples include mutual funds, pension funds, asset managers, and insurance companies. Real money participants are very conservative and look to ride low-risk trends. Just like the previous other market participants, they have huge capital at their disposal and their presence should affect your trading decisions. For example, if your news feed reports that real money have been buying in EUR/USD in the past few weeks, you know they are accumulating long EUR/USD positions and as an order flow trader you should find out why they are doing so (sentiment) and how this affects your trading decisions.

Commercial businesses and corporations

Commercial businesses and corporations trade FX to conduct international business operations and manage currency exposure. They usually trade options contracts, but use the spot market to hedge their positions and manage their risk. Managing risk is their number one goal and they are not profit-based traders. We should take into account their activities in the market, trade sizes, and how it could affect our trading decisions, but since they aren't profit-based, we shouldn't follow their actions and assume they will be on the right side of the market. Commercial transactions are always on both sides of the market and they help create support/resistance levels by buying when price falls and selling when price rises to lock in the best prices.

Retail traders

Retail traders are profit-motivated speculators that usually approach trading with the "get rich quick" mindset. Most lack the discipline and psychology required to trade, and only a very small percentage of retail traders are successful. Retail traders usually place small stops at highly predictable places due to the popularity of technical analysis, and are ripe for exploitation by other market participants searching for liquidity. It is estimated that retail participants order flow accounts for only around 10% of the FX market.
I wrote the above 4 posts four months ago and my views may or may not have slightly changed on some of it. I only skimmed through it so don't expect it to be perfect. For the most part, though, it's solid information and new traders should learn the basic structure of the assets/instruments they trade as it provides huge benefits in knowing what influences price and why it reacts the way it does. Good luck and I hope a few of you can learn something. Any opinions and feedback is welcome!

-FXMasterSK
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